Accounting for taxes in your valuation

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October 09, 2019

by a searcher from The University of Chicago - Booth School of Business in Chicago, IL, USA

Traditional CAPM driven valuation accounts for taxes at the corporate level but does not consider the personal taxes of the investor. For instance, the CAPM discount rate and free cash flow calculations used to calculate intrinsic value account for the 21% corporate tax rate but do not account for individual capital gains taxes or dividend taxes. When valuing flow-through entities like LLCs or partnerships, how are you accounting for taxes? Just using the corporate tax rate for comparability? Are you adjusting the tax rate down from the corporate level to account for some benefit of the flow-through? Using zero as a tax rate because the flow-through entity doesn’t pay taxes? Interested in what others are doing as well as any published approaches (academic or from practitioners).

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Reply by a lender
from University of Missouri in St. Louis, MO, USA
from a lending perspective we traditionally use 27% of EBITDA. This was the number a couple of different CPAs gave us to use. There isn't a magic number since each state has different tax rates and taxable income will vary based on the depreciation and/or amortization deduction available. So in a broad stroke we deduct 27% on EBITDA to accommodate the tax liability independent of the entity structure. Even if there is a pass through via being an S Corp money will still need to flow out of the business in the form of a distribution to cover taxes
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Reply by a searcher
from Harvard University in Chicago, IL, USA
Hi Joe - this is just one person's POV, but I'm baking in 40% taxes into my model as tax distribution for the equity holders of the LLC. So to calculate cash available for debt repayment or equity, I'm subtracting interest and this tax distribution amount from the unlevered cash flow.

Would love to hear how others are thinking about it -- particularly those with flow-through entities that have preferred equity in the capital structure.
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