hard · Principles of Finance valuation

Under which assumption about the firm's financing policy is the textbook after-tax WACC (with a constant cost of equity relation derived from a fixed debt-to-value ratio) the theoretically consistent discount rate, and what does this imply for discounting the tax shield?

1. The firm rebalances debt continuously to a fixed market-value leverage ratio, so the tax shield shares the operating assets' risk and is discounted at the unlevered cost of capital (except the first period).
2. The firm holds debt at a fixed dollar amount (preset schedule), so the tax shield is safe and must be discounted at the cost of debt to match WACC.
3. The firm targets a fixed leverage ratio, so the tax shield is riskless and is therefore discounted at the risk-free rate in both WACC and APV.
4. The firm's leverage is irrelevant under Modigliani-Miller with taxes, so the tax shield discount rate does not affect the equivalence of WACC and APV.

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