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Firm valuation with state dependent COD taxation

  • Standard models on firm valuation, incorporating risky debt, assume a certain tax treatment of a cancellation of indebtedness (COD). Most valuation procedures solely discuss two polar cases: either the COD is strictly taxed on its entirety or not taxed at all. Considering the predominant national tax jurisdictions in G7 and many other countries, this assumption is far from being realistic. We model a state dependent taxation of a COD considering the firm's state in default and further contingencies, including a partial taxation. We show how to include this stochastic interdependency into the pricing of the value of the tax shield and the WACC. Compared to the case of full taxation of a COD this potentially increases the value of tax savings and decreases the discount rate, since less taxes are paid in states with exceptions of a tax on a COD, vice versa for the case of no taxation on a COD. Furthermore, in case of an exemption from taxation of a COD, pricing equations depend on the distribution of total losses on interest and principal payments.

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Document Type:Article
Author:Max Fischer, Marko KrauseORCiD, Alexander LahmannORCiD, Franziska Stimper
Chairs and Professorships:Chair of Mergers & Acquisitions
Parent Title (English):The quarterly review of economics and finance
Issue:May 2022
Date of Publication (online):2020/10/15
First Page:550
Last Page:561
COD; Risky debt; Tax savings; Tax treatment of cancelled debt
Content Focus:Academic Audience
Peer Reviewed:Yes
Rankings:AJG Ranking / 2
VHB Ranking / B
SJR Ranking / Q2
Licence (German):License LogoUrheberrechtlich gesch├╝tzt