Taxation, Uncertainty, and the Cost of Equity |
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Authors: | Diderik Lund |
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Affiliation: | (1) Department of Economics, University of Oslo, P.O. Box 1095, N-0317 Oslo, Norway |
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Abstract: | Traditionally the pre-tax cost of capital is a function of the interest rate and the tax system. However, uncertainty implies that the market's required return is no single interest rate, but depends on risk. Different tax systems split risk differently between firm and government. Thus the required expected return after corporate taxes depends on the tax system. Expressions for this are derived, based on a CAPM-type model. The weighted average cost of capital is decreasing in the tax rate, even for fully equity financed projects. This effect can be substantial, but is neglected in much of the literature. |
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Keywords: | corporate tax depreciation schedule weighted average cost of capital cost of equity uncertainty |
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