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 instead holds debt at a fixed dollar amount on a preset repayment schedule, so the resulting shield is as riskless as the debt itself and must be discounted at the cost of debt to match WACC.
3. The firm targets a fixed leverage ratio in every period, so the tax shield is treated as essentially riskless cash and is therefore discounted at the risk-free rate under both the WACC and the APV approaches.
4. The firm's chosen leverage policy is irrelevant under Modigliani-Miller with corporate taxes, so the discount rate applied to the tax shield never affects whether the WACC and APV valuations ultimately coincide.

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