Taxes Issue in a DCF | Wall Street Oasis

http://www.wallstreetoasis.com/forums/dcf-with-operating-losses-nol

this may help, from a quick skim it doesn't address the wacc issue. but lets be honest, dcf is bull, use one wacc at the marginal, trying to defend your assumptions on your double wacc approach could get tricky.

further:

"Full Question:
How do you factor net operating losses (NOLs) in valuation? I try to determine the nol present value and add it to the enterprise value. This approach is very speculative, so I try to exclude NOLs from my valuation analysis unless I feel fairly confident the company/acquiror could use these assets.

WST Expert Response:
NOLs are trickier - they are not typically factored directly as an asset with value in the sense of equity, debt and enterprise value, but rather, decreases the cash taxes paid, increasing free cash flow and thereby increasing overall value. Of course, NOLs can be valued separately by modeling out future cash flows with and without NOLs, then taking the differences in PV. However, in an M&A context, it gets trickier because if there's a change of control, you are limited to the amount of NOLs you may use each year, roughly estimated as the risk-free rate times beginning NOL balance. So if you had $100 NOL and the 10-yr treasury is 5%, you can only use $5 NOL each year until depleted (20 yrs in this case). A tax attorney should be consulted!! Either way, I don't think I would advise adding NOLs to enterprise value as they are related to operations and not financing. However, if they are significant, then perhaps you would increase purchase price since that means higher expected future cash flows. In general, you just take the balance sheet as is. The same idea applies to accounts receivable - you wouldn't add that to enterprise value. Of course, there are exceptions, as in K-Mart's case when it was bought for it's real estate.

Follow-on Question:
My company (a TLC operator) has a huge amount of tax losses carried forward expected to be used in the forthcoming 4 - 5 years. In my DCF valuation, I have discounted in the Unlevered Free Cash Flows, the income taxes at 33% (ires rate for Italy) as if the Co. has no NOLs to offsed the taxable income base. I computed the savings for NOLs, equal to the PV of the tax shields on the next 4 -5 years EBT, as a surplus assets (adding it to the Enterprise Value). The issue is: which actualisation rate should I use to discount the tax shields? WACC or K(e)? I would exclude the K(d).

Response:
The way we would account for NOLs in a DCF analysis is to reduce the "cash taxes" paid, thereby increasing Free Cash Flow to Firm and thus, increasing the PV of FCFF in the 4-5 year projection period. If there are significant NOLs still remaining after that, we would treat the PV of the tax shields as if it were cash, so it would affect the Net Debt calculation and thus, equity value, but not Enterprise Value. In short, the question of which discount rate to use (WACC or Ke) is not required. Logic: if you have two companies that are exactly the same and generates the exact same future cash flows, except one has NOLs and one doesn't, the overall value of the firm is still the same - only the equity value is affected => meaning that if you were absolutely certain the NOLs would be utilized, it is like having cash in your pocket and so, Equity Value is increased (source of funds) but not Enterprise Value."

Source: http://www.wallstreetoasis.com/forums/taxes-issue-in-a-dcf

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