Valuation, Tax Shields and the Cost-of-Capital with Personal Taxes: A Framework for Incorporating Taxes

This pap er presents a general approach to deriving valuation mo dels and the relevant costof capital formulas indep endent of a particular tax environment. The value of a leveredfirm dep ends to a large extent up on the amount and value of the tax shields. The latterin turn differs from country to country and even from firm to firm, dep ending on itsparticular situation. It is sub ject to change with every change in the tax system of thecountry where the firm is lo cated. Therefore, in an international environment a generalapproach is needed, which can b e altered for any given situation. At the same timep ersonal taxes play an increasing role in the valuation of companies. Therefore, theirconsideration is integrated into the mo dels derived. Finally, the resulting generalizedversions of the Mo digliani/Miller- and Miles–Ezzell-Formulas for adjusting the cost ofcapital to changes in leverage are applied to the situation of a corp oration lo cated inGermany after the Tax Reform Act of 2000.