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Calculating tax shields from financial expenses with losses carried forward

Author

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  • Ignacio Velez Pareja

Abstract

When calculating the Weighted Average Cost of Capital (WACC), the well-known textbook formula includes tax shields with the (1-T) factor affecting the contribution of debt to WACC. In this work we develop a procedure for properly calculating tax shields including the case when Losses Carried Forward are allowed and there is Other Income. The proper calculation of tax shields is relevant because the value of tax shields might be a substantial part of firm value. We show that tax shields depend on Earnings before Interest and Taxes and therefore the risk of tax shields is the risk of the free cash flow; this is the cost of unlevered equity.

Suggested Citation

  • Ignacio Velez Pareja, 2010. "Calculating tax shields from financial expenses with losses carried forward," Proyecciones Financieras y Valoración 7071, Master Consultores.
    • Handle: RePEc:col:000463:007071
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    File URL: http://ssrn.com/abstract=1604082
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    More about this item

    Keywords

    Weighted average cost of capital; WACC; firm valuation; tax shields; tax savings; losses carried forward;
    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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