The valuation of tax shields induced by asset step-ups in corporate acquisitions

We derive discount rates for depreciation and amortization tax shields resulting from asset step-ups in corporate mergers and acquisitions. By assigning all relevant sources of uncertainty for such kind of tax shields and by accounting for corporate debt it is shown that for APV valuations r*, a rate between the firm's cost of debt and the risk-free rate, is adequate to discount step-up induced depreciation benefits. When the benefits are valued on a standalone basis, the adequate discount rate is the after-tax weighted average of r*. Discount rates for these shields have been determined arbitrarily in empirical research on corporate acquisitions so far. However, they are found to be in line with the rates deduced in this paper.