The slicing approach to valuing tax shields

The literature develops the theoretical rationale for the Value of Tax Shields (VTS) on the following misguided basis: it uses required rate of return on assets (or WACC) as the discount rate for capitalization, it uses expected rate of return on assets (ROA¯ or ROI¯) as a proxy for WACC, and it is not aware of (1) the influence of the difference between “expected rate of return on equity” and “Required rate of Return On Equity (RROE)” on VTS, (2) the fact that RROE is equity normal profit which is not measurable, (3) the economic content of the weight attached to the VTS capacity, and (4) the co-definition of “tax shield and leverage return.” This paper takes tax shields and leverage return as a system and provides a knife, “interest rate/ROI = Cost/Price”, to slice the VTS capacity into “earned VTS” and “unearned VTS.” Earned VTS is VTS. Unearned VTS is the value of leverage return, because leverage return is tax payable.