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Comments on "A reconsideration of tax shield valuation" by Enrique R. Arzac and Lawrence R. Glosten

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  • Fernandez, Pablo

    (IESE Business School)

Abstract

While Arzac and Glosten (2005) affirm that "the value of tax shields depends upon the nature of the equity stochastic process, which, in turn, depends upon the free cash flow process," I prove that the value of tax shields depends only upon the nature of the stochastic process of the net increase of debt. Arzac and Glosten (2005) formulate the constant leverage ratio assumption as Dt = L•Et. The assumption of Fernández (2004) is E{Dt}= L•E{Et}, where E{•} is the expected value operator, D the value of debt, E the equity value, and L a constant. The Arzac and Glosten (2005) assumption requires continuous debt rebalancing, while mine does not. Under both financial policies, the expected leverage ratio is constant, but the Arzac and Glosten (2005) assumption is too extreme.

Suggested Citation

  • Fernandez, Pablo, 2004. "Comments on "A reconsideration of tax shield valuation" by Enrique R. Arzac and Lawrence R. Glosten," IESE Research Papers D/578, IESE Business School.
    • Handle: RePEc:ebg:iesewp:d-0578
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    File URL: http://www.iese.edu/research/pdfs/DI-0578-E.pdf
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    References listed on IDEAS

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    1. Enrique R. Arzac & Lawrence R. Glosten, 2005. "A Reconsideration of Tax Shield Valuation," European Financial Management, European Financial Management Association, vol. 11(4), pages 453-461, September.
    2. Myers, Stewart C, 1974. "Interactions of Corporate Financing and Investment Decisions-Implications for Capital Budgeting," Journal of Finance, American Finance Association, vol. 29(1), pages 1-25, March.
    3. Fernandez, Pablo, 2004. "The value of tax shields is NOT equal to the present value of tax shields," Journal of Financial Economics, Elsevier, vol. 73(1), pages 145-165, July.
    4. Miles, James A. & Ezzell, John R., 1980. "The Weighted Average Cost of Capital, Perfect Capital Markets, and Project Life: A Clarification," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 15(3), pages 719-730, September.
    5. Nicholas X. Wonder & Paul Fieten & Lutz Kruschwitz & y otros (ver lista abajo), 2003. "Comment on 'The Value of Tax Shields is NOT Equal to the Present Value of Tax Shields', Including an Arbitrage Opportunity," Proyecciones Financieras y Valoración 2163, Master Consultores.
    6. Gordon A. Sick, 1990. "Tax-Adjusted Discount Rates," Management Science, INFORMS, vol. 36(12), pages 1432-1450, December.
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    More about this item

    Keywords

    Value of tax shields; required return to equity; cost of capital; net increase of debt;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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