Tax Implications on WACC and Beta (Using Pure Play Method)

[mbjones21]

Just Need clarification in regards to Increasing (Decreasing) Tax Rates. If a tax rate Increases (decreases) it will decrease (increase) the WACC for a project.

For the pure play method a increase(decrease) in tax rate will decrease (increase) Beta correct?

Thanks in advance

[busprof]

Decreases both. In WACC, it lowers the after-tax cost of debt.

In pure-play, it decreases the “multiplier” - the (1+D/E(1-t)) that is multiplied times the unlevered beta to get the levered beta.

Although not asked, it would also affect the cash flows from the project. But the direction of the effect on projetc cash flows varies by project. If you calculate cash flows as (With R= Revenues, C=Costs, D=Depreciation):

(R-C)(1-t) + D(t), the relative size of (R-C) and D could result in cash flow increasing, decreasing, or staying unchanged.

[adekunle]

@busprof

Decreases both. In WACC, it lowers the after-tax cost of debt.

In pure-play, it decreases the “multiplier” - the (1+D/E(1-t)) that is multiplied times the unlevered beta to get the levered beta.

Although not asked, it would also affect the cash flows from the project. But the direction of the effect on projetc cash flows varies by project. If you calculate cash flows as (With R= Revenues, C=Costs, D=Depreciation):

(R-C)(1-t) + D(t), the relative size of (R-C) and D could result in cash flow increasing, decreasing, or staying unchanged.

What about the equity component of WACC?

[busprof]

@adekunle

@busprof

Decreases both. In WACC, it lowers the after-tax cost of debt.

In pure-play, it decreases the “multiplier” - the (1+D/E(1-t)) that is multiplied times the unlevered beta to get the levered beta.

Although not asked, it would also affect the cash flows from the project. But the direction of the effect on projetc cash flows varies by project. If you calculate cash flows as (With R= Revenues, C=Costs, D=Depreciation):

(R-C)(1-t) + D(t), the relative size of (R-C) and D could result in cash flow increasing, decreasing, or staying unchanged.

What about the equity component of WACC?

It would also decrease, based on similar logic to what was stated above when answering the question about pure play betas. Sorry I missed it. But it did give me a good idea for a series of questions for my next Corp Finance class. MWA HA HA.