Do German Firms Earn the Cost of Capital Considering Tax Effects caused by Debt and Provisions?

Article (PDF Available) · April 2002with 38 Reads
Abstract
caused by Debt and Provisions? In this paper the performance of a sample of German companies is measured by comparing the initially invested capital adjusted for cost of capital, dividends paid, share repurchases and equity raised with the market value at the end of the holding period. All possible holding periods between 1987 and 2000 are covered. The sample is subdivided into companies listed in the DAX-, MDAX- and SMAX-index. Performance is measured based upon the actual capital structure (levered performance) and also after assuming the company is financed by equity entirely (unlevered performance). It can be shown that tax shields on debt and provisions contribute considerably to levered performance. This applies especially to the subsample of DAX companies. These tax effects turn value decreasing holding periods into value increasing holding periods for a number of cases. If the tax disadvantage on bond income as in Miller (1977) is considered, tax effects of debt financing are close to zero or are even negative depending upon the level of tax free capital gains assumed. Tax shields on provisions exceed tax shields on debt quite regularly.
Figures - uploaded by Andreas Schueler
Author content
All content in this area was uploaded by Andreas Schueler
This research hasn't been cited in any other publications.
  • Article
    This paper provides an approach for developing risk-adjusted discount rates that follows naturally from the standard presentation of the weighted average cost of capital. In addition to examining the implied assumptions about the valuation of corporate debt, the paper shows the pedagogic advantages of the proposed approach.
  • Article
    Do taxes affect corporate debt policy? This paper tests whether the incremental use of debt is positively related to simulated firm-specific marginal tax rates that account for net operating losses, investment tax credits, and the alternative minimum tax. The simulated marginal tax rates exhibit substantial variation due to the dynamics of the tax code, tax regime shifts, business cycle effects, and the progressive nature of the statutory tax schedule. Using annual data from more than 10,000 firms for the years 1980–1992, I provide evidence which indicates that high-tax-rate firms issue more debt than their low-tax-rate counterparts.
  • Article
    Nowadays, every textbook on corporate finance uses the WACC approach for valuating tax savings on interest rates. This approach, going back to Miles and Ezzell (1980), still lacks the restriction of a constant leverage ratio. In this paper it is shown how the WACC formula has to be modified for an arbitrary, but deterministic leverage ratio. Furthermore, it is shown that the original proof of Miles and Ezzell contained two flaws and was incomplete. Finally, we extend the WACC formula to a time continuous setup. JEL-class.: G 32
  • Article
    IN A well-known series of papers Franco Modigliani and Merton Miller^ have out- lined a general framework for the analysis of the effects of capital structure and divi- dend policies on the valuation of the corpo- ration under uncertainty. What disagree- ment remains about their conclusions stems mainly from different beliefs about the effects of various market imperfections on their analysis.- Modigliani and Miller them- selves have dealt comprehensively with one such imperfection, namely the tax system as it affects corporations directly.^ However, while they have directed attention to the effects of the tax system as it relates to the taxation of corporate income, their papers are characterized by an ailmost total neglec; of the complementary aspect of the system, which is the taxation of individuals. It is the purpose of this paper to extend their analysis to incorporate the effects of those features of the personal tax structure which are relevant for the valuation of the corpo- ration. Two features of the personal tax struc- ture stand out in importance for the theor}' of valuation. First is the provision of the existing tax code which permits individuals as well as corporations to deduct interest
  • Article
    This paper reviews the theory and evidence regarding the impact of taxation on corporate financial policy. Starting from a basic characterization of the classical corporate income tax and its effects, the analysis focuses on three areas of research: equity policy, debt-equity decisions, and choices regarding ownership structure and organizational form. The discussion stresses the distinction between nominal and more fundamental financial differences – for example, in the relationship between borrowing and leasing – and that financial policy involves choices not only among different underlying policies but also among characterizations of a given policy. The final section offers some brief reflections on the implications of continuing financial innovation.
  • This is the sequel to the authors' 1989 article discussing the two basic discounted cash flow approaches for valuing debt-financed transactions and corporations: weighted average cost of capital (WACC) and adjusted present value (APV). The WACC method discounts all after-tax (but pre-interest) cash flows at the company's weighted average cost of capital. The APV method treats the value of a levered firm as the value of the same firm if financed entirely with equity plus the discounted value of the interest tax shields from the debt its assets will support. The authors argue that the WACC approach is more practical if the firm intends to hold its (market) leverage ratio relatively constant over time, but that the APV technique is the preferred method if the firm plans to reduce its leverage ratio according to a pre-determined schedule (as tends to be the case in highly leveraged transactions). 1997 Morgan Stanley.
  • Article
    We survey 392 CFOs about the cost of capital, capital budgeting, and capital structure. Large firms rely heavily on present value techniques and the capital asset pricing model, while small firms are relatively likely to use the payback criterion. A surprising number of firms use firm risk rather than project risk in evaluating new investments. Firms are concerned about financial flexibility and credit ratings when issuing debt, and earnings per share dilution and recent stock price appreciation when issuing equity. We find some support for the pecking-order and trade-off capital structure hypotheses but little evidence that executives are concerned about asset substitution, asymmetric information, transactions costs, free cash flows, or personal taxes.