Is the Value of the New Business Tax Shield Lower? Comparative Study of International Valuation Methods

Abstract

The macroeconomic environment has been characterized by strong GDP growth in recent years. The favourable conditions allow the growth of new innovative businesses (start-ups), which support multiplier economic development. New businesses are often unprofitable in the first years of existence; there is a higher probability of default. The issue of start-ups may be insufficient funding, high costs of financial distress and resulting low corporate value and unattractiveness for investors. The aim of this paper is to analyse and evaluate which of the existing methods of quantifying the debt tax shield is suitable for start-ups. Three different approaches have been chosen to calculate the interest tax shield; Modigliani-Miller (1963) model for imperfect capital markets and two models from Velez-Pareja (2013,2016). The results were obtained by correlation analysis of more than 5,000 Slovak businesses, the impact of the age of the business on the value of tax shield was examined. Also, the impact of the industry on the value of tax shield was explored. The results of the analysis suggest that the quantification by Modigliani-Miller (1963) formula does not take sufficient into account of the age of company. In contrast, the Velez-Pareja (2013, 2016) models are suitable for start-ups, because they take into account the potential tax shield, which occurs when the operating income cannot cover financial costs (especially interest paid). In innovative industries, start-ups often do not reach the traditional tax shield, but their value may be higher using an alternative formula by Velez-Pareja.