(Re-)Financing Policies and the Value of Debt-Related Tax Shields

Abstract

The tax shield as present value of debt-related tax savings plays an important role in firm valuation. Driving the risk of future debt levels, the firm's strategy to adjust the absolute debt level to future changes of the firm value, labeled as (re-) financing policy, affects the value of tax shields. Standard discounted cash flow (DCF) models offer two simplified (re-) financing policies originally introduced by Modigliani and Miller (MM) as well as Miles and Ezzell (ME). In this paper we show that both policies are special and polar cases of a general model of financing policies referring to the firm's choice of debt refinancing intervals. We derive general valuation and cost of capital equations allowing flexibly incorporating any refinancing sequence. By combining capital structure and maturity structure choices our model extends the set of feasible financing policies in DCF valuation models.