Part 1 - AL-Tax

International Taxation Handbookand receipts). In this case, the cost of opportunity, otherwise known as the capitalasset pricing model (CAPM), should be adopted. Any benefits obtained fromthe tax effects should influence the residual value of shareholder flow.The second way is through use of the ‘free cash flow’, which is obtained from‘earnings before tax and interest’ (EBIT), where the tax paid (on EBIT) is used toidentify the net income (without debt). The ‘free cash flow’ is therefore equal tonet income (without debt), plus depreciation, minus fixed assets and workingcapital (see Fernandez, 2002). Note that free cash flow should be discounted usingthe weighted average cost of capital (WACC) (including the cost of debt).The ‘free cash flow’ provides the value of stockholder equity, but it also illustratesthe company’s value. The difference between equity cash flow and freecash flow is the value of the debt. The same result could be obtained by discountingthe cost of debt from its cash flow.During the multinational company valuation process, it is important to analyzethe tax effects in the countries where the investment will occur. The taxeffects will influence the generation of cash flow (CF) or the discount rate (i),according to Reilly and Schweihs (2000).One of the more traditional ways of studying tax effects in the valuationprocess is to consider the cost of capital. Financial expenses are usuallydeductible for tax purposes, so the net cost of debt is the interest reduced by thetax benefit (Pratt, 1998), as follows:k dt k d (1 t),where k dt the cost of debt adopted for the discount, k d the interest rate of theloans, and t the tax rate (percentage of net income).Finally, the debt cost value should also be considered when estimating WACC.Considering that tax is a payment and could influence the WACC, ‘any actionthat can reduce the tax burden on a firm for a given level of operating income willincrease value’ (Damodaran, 2001, p. 408). Damodaran gives the following example:A multinational company that generates income from different countries may beable to move to a low- or no-tax country using transfer pricing.In any event, in order to obtain the generated flow of the multinational in a certaincountry (V c ), it is important to adopt the effective tax rate of each countrywhere the flow is generated. The tax cost of the foreign capital in a given countrycould be different from this rate because of local legislation, or according to thecapital allocation. The tax legislation of a given country could also allow tax benefitsfor foreign companies, however.328