DP13277 Valuation in the Public and Private Sectors: Tax, Risk, Debt Capacity, and the Cost of Capital

Author(s): Richard Brealey, Ian Cooper, Michel Antoine Habib
Publication Date: October 2018
Keyword(s): cost of capital, debt capacity, private sector, Public sector, risk, tax, Valuation
JEL(s): G18
Programme Areas: Financial Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=13277

The public and private sector costs of capital differ in the presence of taxes, because taxes are a cost to the private but not the public sector. We use a quasi-arbitrage approach to show how to include taxes in a comparison of capital costs. We find that taxes induce distortions that generate a systematic private sector preference for assets with rapid tax depreciation, high debt capacity, and low risk. We examine the implications of that preference for privatization, government outsourcing, and regulation. Our approach facilitates the analysis of transactions such as pure risk transfers, otherwise difficult using standard discounting methods.