Abstract
AbstractIn this paper we develop a model to value debt related tax savings and associated yield rates for debt in a setting where future cash flows are uncertain and follow a stochastic diffusion process. By explicitly modeling a default trigger we find that tax shield values in standard Discounted Cash Flow (DCF) valuation formulas are too high as they do not correctly incorporate the risk of default. Furthermore, we are able to endogenously derive risk-adjusted yield rates, while keeping the overall simple and tractable structure of the DCF approach.
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