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Why do we use risk-free rate while calculating the PV for tax shield in the APV calculation?
Thank you
You can use either the risk free rate, or Kd to calculate the tax shield – their are arguments for both and the examiner always accepts either (as I explain in my free lecture on this).
The reason is that we should discount at the the rate applicable to the riskiness of the tax shield, which is the same as the riskiness of the debt itself. Because we are effectively M&M, then in theory the debt (and therefore the tax shield) should be risk free.
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