Study of large public projects confirms public/private value differences result from a ‘tax wedge’

BVWire–UKIssue #9-2
December 17, 2019

cost of capital
cost of capital, discount rate, tax

Richard Brealey and Ian Cooper of London Business School, along with Michel Habib of the University of Zurich, have published a new study on taxes and value in the public sector. The study, published in the Journal of Business Finance & Accounting, establishes ‘the existence of a tax-induced wedge’ between private- and public-sector financing of huge capital projects such as toll roads or power plants ‘because taxes are a cost to the private sector but are only a transfer to the public sector.’ They conclude that this leads investors to more highly valued private enterprises with rapid tax depreciation, high debt capacity, and low risk.

While these cost of capital analyses are uncommon for most BVWire—UK readers, the study is helpful since it supports the practice of most business valuators when they assign higher values and lower cost of capital conclusions to private assets with these same characteristics. The study also provides mathematics to compare private investment tax shields with the UK Treasury’s present value project evaluation techniques.

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