Interest Tax Shields: A Barrier Options Approach

Interest Tax Shields: A Barrier Options Approach There is a link between barrier options and tax shields of interest expense. We combine this link with a traditional valuation approach, to present practical valuation formulas for interest tax shields in three debt scenarios with risk of default: (1) constant debt, (2) delayed debt, and (3) debt refinancing. In all cases, default and refinancing are contingent on the random evolution of the income of the firm. For each scenario, we work out sensitivity analysis of the value of tax shields with respect to income, growth, systematic and business risk, risk-free interest rate, interest coverage ratio covenant, and the firm’s refinancing strategy. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Quantitative Finance and Accounting Springer Journals

Interest Tax Shields: A Barrier Options Approach

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Publisher
Springer US
Copyright
Copyright © 2012 by Springer Science+Business Media, LLC
Subject
Finance; Corporate Finance; Accounting/Auditing; Econometrics; Operation Research/Decision Theory
ISSN
0924-865X
eISSN
1573-7179
D.O.I.
10.1007/s11156-012-0282-3
Publisher site
See Article on Publisher Site

Abstract

There is a link between barrier options and tax shields of interest expense. We combine this link with a traditional valuation approach, to present practical valuation formulas for interest tax shields in three debt scenarios with risk of default: (1) constant debt, (2) delayed debt, and (3) debt refinancing. In all cases, default and refinancing are contingent on the random evolution of the income of the firm. For each scenario, we work out sensitivity analysis of the value of tax shields with respect to income, growth, systematic and business risk, risk-free interest rate, interest coverage ratio covenant, and the firm’s refinancing strategy.

Journal

Review of Quantitative Finance and AccountingSpringer Journals

Published: Mar 30, 2012

References

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