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IESE Research Papers,
IESE Business School

No D/613: The value of tax shields depends only on the net increases of debt

Pablo Fernandez ()
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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. By applying this formula to specific situations, we show that Modigliani-Miller (1963) should be used when the company has a preset amount of debt, Fernández (2004) when the company maintains a fixed book-value leverage ratio, and Miles-Ezzell (1980) when the company maintains a fixed market-value leverage ratio.

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 25, 2005

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DI-0613-E.pdf PDF-file

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