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Return to basics: are you properly calculating tax shields?

Author

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  • Ignacio Velez-Pareja

Abstract

Everybody uses tax shields when calculating the Weighted Average Cost of Capital (WACC). The textbook formula includes the tax shield with the (1-T) factor affecting the contribution of debt to the WACC. Tax shields are a strange mix of accounting and accrual related to WACC that relies on market values. In this short work we show some limitations and care that have to be taken when using tax shields. We illustrate these ideas with simple examples.

Suggested Citation

  • Ignacio Velez-Pareja, 2008. "Return to basics: are you properly calculating tax shields?," Proyecciones Financieras y Valoración 5152, Master Consultores.
    • Handle: RePEc:col:000463:005152
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    File URL: http://papers.ssrn.com/abstract=1306043
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    Cited by:

    1. Lucia MICHALKOVA & Tomas KLIESTIK, 2019. "The Role Of Risk In The Valuation Of Tax Shield," Proceedings of the INTERNATIONAL MANAGEMENT CONFERENCE, Faculty of Management, Academy of Economic Studies, Bucharest, Romania, vol. 13(1), pages 218-233, November.

    More about this item

    Keywords

    Weighted average cost of capital; WACC; firm valuation; capital budgeting; tax shields; tax savings;
    All these keywords.

    JEL classification:

    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate

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