European Business Schools Librarian's Group

IESE Research Papers,
IESE Business School

No D/612: The value of tax shields with a fixed book-value leverage ratio

Pablo Fernandez ()
Additional contact information
Pablo Fernandez: IESE Business School, Postal: Research Division, Av Pearson 21, 08034 Barcelona, SPAIN

Abstract: The value of tax shields depends only on the nature of the stochastic process of the net increases of debt. The value of tax shields in a world with no leverage cost is the tax rate times the current debt plus the present value of the net increases of debt. We develop valuation formulae for a company that maintains a fixed book-value leverage ratio and show that it is more realistic than to assume, as Miles-Ezzell (1980) do, a fixed market-value leverage ratio. We also show that Miles-Ezzell assume that the increase of debt is proportional to the increase of the free cash flows.

Keywords: Value of tax shields; present value of the net increases of debt; required return to equity

JEL-codes: G12; G31; G32

30 pages, October 15, 2005

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DI-0612-E.pdf PDF-file

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