- 28 -
Although perhaps less likely, Mr. Wilhoite may believe that,
as a matter of proper application of a present value analysis,
Dr. Bajaj was required to tax affect G&J’s expected distributions
on account of the expected tax burden to be borne by its
shareholders. Dr. Bajaj assumed that G&J would continue to
distribute all of its earnings annually. He made no explicit
adjustment for any shareholder level taxes, although,
undoubtedly, he knew such taxes would be due. Dr. Bajaj did not,
however, ignore shareholder level taxes. He simply disregarded
them both in projecting G&J’s available cash and in determining
the appropriate discount rate. The present value of any future
(deferred) cash-flow is a function of three variables: (1) the
amount of the cash-flow, (2) the discount rate, and (3) the
period of deferral.11 The discount rate reflects the return,
over time, to the investor on the amount invested (commonly
expressed as a rate of interest). If, in determining the present
value of any future payment, the discount rate is assumed to be
an after-shareholder-tax rate of return, then the cash-flow
should be reduced (“tax affected”) to an after-shareholder-tax
amount. If, on the other hand, a preshareholder-tax discount
rate is applied, no adjustment for taxes should be made to the
11 PV = C/(1+r)n, where PV equals the present value, r equals
the discount rate, C equals the cash-flow, and n equals the
number of periods of deferral.
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