Business Valuation with Attention to Imputed Interest on Equity Increase – a Comparison of Alternative Pricing Methods in a Model with Stochastic Profitability

As early as the 1980s, several European countries implemented tax systems with imputed equity interest provisions. Since its tax reform in 2000, Austria has also allowed the deduction of (fictitious) imputed equity interest from the tax base. This paper integrates the resulting tax benefits related to equity into the valuation of corporations. Using the equity method with attention to the deductibility of imputed equity interest, the value of a business is calculated in a multi-period model. In this context, a market-to-book ratio endogenous to the model results for the equity of the valuated business. It is then demonstrated how to apply the APV method in a model with imputed equity interest. For each business - and thus also for an unlevered company - an adjustment is necessary to account for the tax shield resulting from equity financing. Therefore, an unlevered company which does not use equity tax shields has to be chosen as a common denominator in the application of the APV method, in which a closedform solution is presented for the value of this tax benefit. Intertemporal differences in risk make it necessary to use various risk-adjusted term structures of interest rates in the equity method as well as the APV method. Finally, the weighted average cost of capital in consideration of the deductibility of imputed equity interest is derived. A sensitivity analysis is conducted for all value components of a business and the weighted average cost of capital