Thursday, February 8, 2018

Lower Taxes, NPV, and Company Value

A major benefit of the Tax Cuts and Jobs Act of 2017 is that it reduces taxes paid, which increases operating cash flow. Increased cash flow can increase the NPV of a project, even turning a negative NPV to a positive NPV, and increase the overall value of a company. Since the value of a project or the value of a company are both based on the present value of future cash flows, this result is fairly obvious. As a recent article points out, what is less obvious is that the reduced tax rate will also increase the required return on a project or a company. Since the cost of debt that is important for either valuation is the aftertax cost of debt, a reduced tax rate actually makes the cost of capital higher, all else the same. So, in discounting higher future cash flows with a higher cost of capital, the present value will not increase as much as you might think at first glance.