Keywords
tax shields
cash flows
Montecarlo Simulation
discount rate for tax shields
risky debt
risky tax shields
weighted average cost of capital
How to Cite
Abstract
This article identifies three sources of risk for tax shields (TS): two of them are associated with debt risk and one is associated with operating risk. A set of conditions for defining risky debt associated with cash flow, not with earnings, is presented. It further shows that realization of tax shields for finite cash flows in a period of time t is correlated with Earnings before Interest and Taxes (EBIT) plus Other Income (EBITO), not with interest expenses at time t. The author questions the validity of Miles and Ezzell’s proposal. With the results of a Montecarlo Simulation (MCS) the behavior of tax shields, Cash Flow to Debt (CFD) and (EBITO) are examined. In conclusion, the article suggests that it is not reasonable to define the risk of TS as measured by a single discount rate, but rather as a mix of debt risk and operating risk.
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