We explore how the recently unveiled Tax Cuts and Jobs Act may affect valuations for taxable entities.
House Republicans recently unveiled their long-awaited plan to restructure the tax code. The Tax Cuts and Jobs Act (full text is accessible here) endeavors to rewrite tax policy for the first time since the Reagan administration. While the policy is far from final, we, as valuation experts, have a particular interest in how the proposed legislation might affect business values.
What Is Proposed?
How Might Values Change? (The Easy Stuff)
The value of a business enterprise depends primarily on its capacity to generate after-tax earnings and cash flows. To a degree, the likelihood of tax reform is already reflected in the stock prices of publicly traded companies. The full value impact from tax reform will be observed only when new legislation is ultimately passed (or not). Thus, below we focus on the Income Approach effects if the proposed legislation were signed into law.
How Might Values Change? (The Hard Stuff)
Intuitively, higher earnings due to lower taxes would lead to appreciation in business values. However, the valuation process is complex, and it requires consideration of cause and effect. Of course, the effect of tax reform is the great unknown, as any new tax plan could have broad-reaching implications and unforeseen consequences on the domestic and international landscape. While answers are scarce, questions abound, including:
- How will lower taxes, and correspondingly higher available cash flow, affect employee wages, investment, dividend policy, and global competitiveness more generally?
- How will repatriated cash be used by businesses?
- If businesses accelerate investment (in employees or otherwise), what financial impact will result from the additional capacity, innovation, or consumer spending, in terms of increased revenue, higher expense, enhanced efficiency, or otherwise?
- Will previously offshored operations be onshored?
- How will limitations on the deductibility of interest expense, but full taxation of interest income, affect market interest rates?
- How will limitations on the deductibility of interest expense affect the leveraged buyout market, and correspondingly financial buyers’ capacity to compete with strategic buyers for M&A transactions? Will the limitation decrease the amount of debt employed by companies to finance M&A transactions, equipment purchases, or other forms of investment?
- How do we think about modern capital allocation theory and optimal capital structures if there are limitations on interest expense deductibility?
- With a $1.5 trillion price tag according to the Joint Committee on Taxation, will there be sufficient economic growth and tax revenue to support even more national debt? Will there be a boost to, or drag on, inflation and/or long-term growth rates?
Compliments of STOUT, a member of the EACCNY