DDP 695. Joseph Tham. "Present Value of the Tax Shield in Project Appraisal: A Note." April 1999. 14 pp.

For some public sector projects it is necessary to estimate the impact of the interest tax shield on the financial cost of capital. With debt financing, the value of the levered firm is increased by the present value of the interest tax shield. In this note, the present value of the interest tax shield is reconsidered. In finance textbooks, it is commonly assumed that the discount rate for the tax shield is d, the risk-free rate for debt. Here, it is shown that the correct discount rate for the tax shield is r, the required rate of return with all-equity financing.

Keywords: tax shield, discount rate and project appraisal

JEL codes: D61, G31, H43

Joseph Tham teaches at the Fulbright Economics Teaching Program (FETP) in Ho Chi Minh City, Vietnam. Previously, he worked with the Program on Investment Appraisal and Management (PIAM) at HIID.