hard · Principles of Finance cost-of-capital-structure

What is the most defensible critique of this treatment for valuing the firm today?

1. The interest tax shield should be deferred: for the first 3 years the marginal tax benefit is effectively zero (so the after-tax cost approaches the 6% pre-tax rate), and only the present value of shields realized in year 4 onward should be capitalized at the 4.5% equivalent.
2. The analyst should gross up the cost of debt to 8% because tax-loss carryforwards make debt strictly more expensive than the coupon during the shelter period.
3. The after-tax cost of debt is correct as computed because the statutory rate is the legally binding marginal rate regardless of the timing of taxable income.
4. Because the firm has a deferred tax asset, the effective tax rate on interest is zero in perpetuity, so the full 6% pre-tax cost of debt should be used for the entire valuation horizon.

Sign up free to see the explanation and track your rank →