Live from NACVA: Tax loss carryforwards add to free cashflow, and change the cost of capital

It makes logical sense that the tax shields provided by tax carryforward losses (TLC) would add free cashflow.  Felix Streitferdt argues that “since the carryforward loss has different risk characteristics than operating cashfow, the company’s cost of capital must be adjusted.”   In his session on the topic at NACVA in Miami this morning, Streitferdt said “we need the current value of the tax loss carried forward and its risk adequate discount rate” which is the same as the current value of the future tax savings from the TLC.   Here’s a point many appraisers may overlook, however:  “when analyzing data from comparable companies, we also need to know whether they have the same tax savings value,” or the comparables may have very different costs of capital.   This could be true when other financial and operating indicators are similar to your subject company.

Leverage can also impact the value of a company with a TLC.  “Because interest payments are deductible, “a leveraged company will have a lower tax bases than a comparable underleveraged company.”  Streitferdt has done research on TLCs and suggests using an adjusted Black-Scholes method to calculate value.   His theory is that these carryforwards behave like “a combination of two European call options; a long call option with a strike price of zero, and a short call option with a strike price equal to the [TLC’s] full current value.”