Simple question about valuation from a lawyer (edited)
Hello,
I am a lowly lawyer (actually worse - a law student), and I have a relatively simple (I think) valuation question that I can't figure out the answer to. Imagine there is company X in which a new policy will place an one-time tax on that company's market cap. Lets say for now that tax is 1%. Assuming this is a perfectly efficient tax (no change in firm behavior), that would mean that we would expect company stock price to decline by 1%. Now imagine that same tax is applied annually as opposed to one time. What would be the change in today's stock price. In other words, how would such a tax affect the present value of such a company.
a 1% one time tax or 1% revenue fee would probably probably only affect the company for 1 or 2 quarters, and then the earnings hit would be filtered out by a twelve month trailing earnings. The real problem is if that fee significantly affects either the profit margin or the balance sheet.
If it were 1% annual expense, then investors would accommodate that fee into a the future estimates of the company, and the new expense would likely have one time hit in the stock price or the stock price would go lower just for a few months or maybe longer - it all depends.
This is not a correct assumption because a company's valuation is not equal to a single year of its earnings, so a 1% tax on a single year's earnings will not drop its valuation by a full 1%. A portion of the company's valuation is based on discounted future earnings, and that would be unaffected by this hypothetical one-time payment. (If the tax payment occurred today, the valuation would fall by the exact dollar amount of the tax, not the percentage of the tax).
On the other hand, reducing earnings by exactly 1% in perpetuity would reduce its valuation by exactly 1%, because the sum of all discounted future cash flows has decreased by exactly 1%.
It would decrease valuation by less than 1% in perpetuity because the Increase in tax rate incentivizes leverage so interest expensive is deductible at higher rate and depreciation will create a higher tax shield increasing cash flows relatively
Edit: just noticed tax is on market cap? That sounds like some democrat moron policy. Year 1 would decrease by less than 1% bc value of all future flows. Perpetuity would be 1%
Ok - I totally grant you that point. I should not have said earnings, but instead a company's valuation. So, a politician proposes a tax that says on Jan 1, whatever company's market cap is, we tax 1% if that.
Sounds like some Elizabeth Warren stupidity tax.
The market value of a company fluctuates daily, so determining the amount on X valuation date may not be accurate or the best way of doing things. Perhaps a weighted daily average of the company market cap over a trailing 365 day period may give a more accurate figure. I feel a company would estimate this tax hit similar to goodwill where the value of the potential tax liability would be tested for impairment on a regular basis and adjusted accordingly.
You would then determine an estimated amount of tax payable based on market cap, and use that figure to project for future years. That amount would likely be greater than 1%, and whatever that amount is you would discount it by some number, and it would reflect in the stock price. That being said, my guess would be that it would effect the stock price by greater than 1%
My question is based on proposed legislation, and one obvious way of evaluating such legislation would be its effect on company valuation. I would love to be able to calculate a defensible number.
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