There are a number of fundamental reasons why this is so: the capital asset pricing model (CAPM), from which dis- count rates are derived, is based on stock market return of shares, which returns are calculated after company tax, and c. That is, after tax cash flows must be discounted at after tax discount rates. Some brief conclusions are offered in Section Consistency between cash flows and discount rate To ensure consistency between the cash flows and the discount rate used, the cash flows and the discount rate should be expressed on a consistent basis.
#VALUATION WITH PRE AND POST TAX CASHFLOWS SERIES#
Section six includes a series of analytical examples which clearly demonstrate the errors which can arise in valuations where the conceptual errors outlined in sections 2, 3 and 4 are not avoided. Section 3 discusses problems associated with the calculation of pre tax cashflows, while Section 4 highlights the problems inherent with the estimation of pre tax discount rates. Section 2 discusses issues relating to the need for consistency in the selection of discount rates to be applied to streams of cashflows. For the reasons outlined below, the preferred (and technically correct) method to discount cash flows is to express cash flows forecasts on an after tax basis, and to discount those cash flows using an after tax discount rate.
However, this is not the case and material errors can arise, unless both the cash flows and the discount rate are after-tax. When discounting pre tax cash flows it is often assumed that discounting pre tax cash flows at pre tax discount rates will give the same answer as if after tax cash flows and after tax discount rates were used. In particular, the paper addresses the matter of problems which arise when inappropriate assumptions are made in relation to the estimation and application of pre tax discount rates. Introduction This article examines the issues associated with the use of pre and post tax discount rates in the conduct of analytical procedures in which cashflow discounting is necessary. JARAF / Volume 4 Issue / 41Ģ THE JOURNAL OF APPLIED RESEARCH IN ACCOUNTING AND FINANCE 1. In light of these, it is argued that discounted cashflow analysis should be configured on the basis of after tax cashflows discounted with after tax discount rates. Drawing upon a series of analytical examples, common conceptual flaws in discount rate and cashflow stream selection are highlighted. 1 Pre and Post Tax Discount Rates and Cash Flows A Technical Note Wayne Lonergan When discounting pre tax cash flows it is often assumed that discounting pre tax cash flows at pre tax discount rates will give the same answer as if after tax cash flows and after tax discount rates were used.
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