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The B.E. Journal of Economic Analysis & Policy

Editor-in-Chief: Jürges, Hendrik / Ludwig, Sandra

Ed. by Auriol , Emmanuelle / Brunner, Johann / Fleck, Robert / Mendola, Mariapia / Requate, Till / Schirle, Tammy / de Vries, Frans / Zulehner, Christine

4 Issues per year


IMPACT FACTOR 2016: 0.252
5-year IMPACT FACTOR: 0.755

CiteScore 2016: 0.48

SCImago Journal Rank (SJR) 2016: 0.330
Source Normalized Impact per Paper (SNIP) 2016: 0.526

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1935-1682
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Volume 6, Issue 1 (Jan 2006)

Issues

Volume 6 (2006)

Volume 4 (2004)

Volume 2 (2002)

Volume 1 (2001)

The Firm's Cost of Capital, Its Effective Marginal Tax Rate, and the Value of the Government's Tax Claim

Ramesh K. S. Rao
  • 1University of Texas at Austin,
/ Eric C Stevens
  • 2
Published Online: 2006-01-23 | DOI: https://doi.org/10.2202/1538-0653.1465

Abstract

This paper develops a theory of the firm's weighted average cost of capital (WACC) and the marginal tax rate with risky debt and potentially redundant depreciation and interest tax shields. The tax shields' risks, the firm’s borrowing interest rate and its marginal tax rate are intertwined, and they must therefore be determined simultaneously. We capture these interdependencies by determining the borrowing interest rate endogenously, using the single-factor approximate arbitrage pricing theory. This research strategy: a) yields the correct discount rate for valuing the tax shields and shows how better WACC and marginal tax rate estimates can be generated, b) identifies the determinants of the firm's debt capacity in terms of asset characteristics and exogenous economic variables and c) specifies, numerically, how policy variables (corporate tax rate, tax rules, the risk-free rate) affect the market values of claims on the firm's output that are both private (debt, equity) and public (the tax claim).

Keywords: cost of capital; marginal tax rate; debt capacity

About the article

Published Online: 2006-01-23


Citation Information: Topics in Economic Analysis & Policy, ISSN (Online) 1538-0653, DOI: https://doi.org/10.2202/1538-0653.1465.

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