Valuing the Tax Benefit of Debt - A Simulation Approach for Swedish Firms

Abstract: A heavily debated topic in corporate finance research concerns the impact of interest tax deductibility on firm value and, in extension, capital structure decisions. In 2014, the Swedish Committee on Corporate Taxation proposed that interest-deductibility should be abolished, making it relevant to quantify the value of these benefits in the Swedish context. This paper attempts to estimate the value of tax savings attributable to interest deductibility by extending a valuation approach developed by John R. Graham (2000) to simulate firm-specific tax benefit functions for a selected sample of Swedish firms. By integrating under the simulated benefit functions, we find that the capitalised tax-reducing benefit of interest averages around 9.8 per cent of book value and 9.0 per cent of market value for our sample. Moreover, we infer how aggressively firms use debt by observing the point of declining marginal tax benefits on each firm-specific marginal benefit function and conclude that Swedish firms are rather conservative in their use of debt.