John Graham
Duke University, Durham, NC 27708
Michael L. Lemmon
Arizona State University
ABSTRACT
Taxes play an important but underemphasized role in the valuation of a company and its projects. We argue that to maximize shareholder wealth, managers should perform a sophisticated analysis of corporate tax incentives as part of their planning process. For example, because interest expense is tax deductible, a manager can lower the cost of capital and increase firm value through the judicious use of debt financing. As another example, firms with low tax rates can lower their cost of capital by financing with leases, because leasing allows low rate firms to transfer tax shields to other firms (lessors) who value them more highly. The magnitude of the potential tax benefits is not trivial. Research by one of the authors finds value, representing $128 billion on an economy-wide basis in 1990. For some firms, especially those undergoing LBOs, the tax benefits can approach 20% of firm value.