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Not an accountant, but isn't it pre-tax wacc?
discount at the cost of equity.
discount at the acquiror's WACC
Always used cost of debt. Nothing risky about that cash flow. as long as there's a net loss pretty much guaranteed
I think you meant as long as there's a net profit to use the NOLs against. I agree on using the cost of debt.
can someone confirm?
I disagree with using the cost of debt for the simple reason that the usage of the NOL is completely predicated on the firm generating positive taxable income, which is a direct function of the riskiness of the firm's operations.
It helps to think about it from a risk perspective: the risk that the company may not be able to use the NOL is the same as the risk that the company may not generate positive taxable income? The WACC is a more appropriate discount rate to use, in my opinion.
Generally, for something as unpredictable as the tax savings of an NOL, you want to be as conservative as possible. Cost of debt is absolutely inappropriate, primarily because of the reason listed above but also because it is lower than cost of equity/WACC (at least a large majority of the time). This will cause a larger PV of NOL savings.
It logically makes sense to use cost of equity. NOL is attributable to pre-tax income, or EBT, so it is attributable to shareholders. Cost of equity is also the highest number of the three "proposed" discount rates (again, a large majority of the time) and will thus result in the most conservative estimate of the PV of the savings.
Bringing this year old thread back to life to ask a question...the last answer was to discount at the cost of equity. But why not just use WACC? Why do tax savings form NOLs have to go only to equity? Can't those tax savings also be used for creditors too?
Really? Im disappointed by the certified users' responses. First of all, it depends if you are valuing the firm or equity. That will tell you if you are using WACC or COE...Most importantly, NOL is taken into account on your cash flows not your discount rate (thats valuation 101). You should use your marginal tax rate when computing WACC, unless this is an all equity funded firm in which case you dont care.
I still don't get how to value NOLs. In my view, they're pretty much guaranteed for a historically profitable company. I think if you think of a company as taking on various projects with various risks and that it ends up generating on average a certain percentage return by taking those risks then NOLs are a zero-risk project...as long as you actually have earnings to count them against. They are also relative: a $10M/yr nol stream to Google is different than it is to a company with only $10M/yr in pre-tax income to begin with. The latter company has significantly greater risk of not being able to use the NOLs than Google does.
As long as the company acquiring the NOLs knows it is going to have at least enough pre-tax profit to be able to exhaust the annual nol limit for the next 15yrs, I don't see why the discount rate isn't just close to a 15yr treasury bond rate (mainly to account for effects of inflation, time value of money, not necessarily riskiness of cash flows).
We're not talking about missing earnings here, we're talking about as long as a company makes enough profit the NOL can and will be used. In Google's specific case, for example when it acquired Nest for $3B, it should've valued any NOLs Nest had at almost risk-free rates.
I do not think it will be appropriate to evaluate NOLs using a Risk-free rate, even if the benefit from NOLs in certain. What you are saying, if I got it correctly is that, since Google is profitable, they will be able to benefit from NOLs hence NOLs benefit should be discounted at a risk-free rate. If this reasoning is correct, then you should also assume that, since Google is profitable for sure, you should discount its earnings at risk-free rate. If this is the case, then we would be miss to consider the risk you need to bare to invest in Google to then benefit from the NOLs Google will have.
To sum up, in my opinion the dilemma should be between WACC, since it is the operating performance of the company than drives your ability to use NOLs, or Cost or Equity, since the tax benefit goes directly to the shareholders, and not to bond holders.
To be honest, I do not have an answer to which discount rate is optimal, but in my office, my VP advices us to use the Cost of Equity for the latter reason. Also, I have found a Blackstone fairness opinion on a distressed company and they used the Cost of Equity.
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