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A Simple Accounting-based Valuation Model for the Debt Tax Shield

Author(s): Andreas Scholze

Journal: BuR : Business Research
ISSN 1866-8658

Volume: 3;
Issue: 1;
Start page: 37;
Date: 2010;
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Keywords: corporate income tax | cost of capital | debt tax shield | equity valuation | financial leverage | financial statement analysis | residual income valuation | Feltham-Ohlson framework

This paper describes a simple way to integrate the debt tax shield into an accounting-based valuation model. The market value of equity is determined by forecasting residual operating income, which is calculated by charging operating income for the operating assets at a required return that accounts for the tax benefit that comes from borrowing to raise cash for the operations. The model assumes that the firm maintains a deterministic financial leverage ratio, which tends to converge quickly to typical steady-state levels over time. From a practical point of view, this characteristic is of particular help, because it allows a continuing value calculation at the end of a short forecast period.
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