Tuesday, 30 May 2017

Computing Operating Taxes

In estimating value, the followings need to be determined:

  • the portion of taxes due from the operating activities,
  • then determine the operating cash taxes, and 
  • finally, estimate the value of the corporation recognizing that some taxes are deferred.

The available information on the analyzed firm will be incomplete, therefore, operating cash taxes can only be estimated and the estimates will have errors.

Using either the company's statutory tax rate or the company's effective rate with no adjustments is not appropriate for computing operating taxes.

Adjustments for Computing Operating Taxes

1.  One suitable approach is to compute taxes as if the company were financed entirely with equity.

  • To accomplish this task, begin with reported taxes and undo financing and nonoperating items one by one.
  • Make estimates based on the tax rates in the various jurisdictions in which the firm operates.  

2.  Estimates of operating taxes actually paid in cash provide a better input for valuation than those estimates that include accruals.

  • As part of the estimation process, subtract the increase in net operating deferred tax liabilities from operating taxes.
  • Information for this process should be in the tax footnote.
  • The reorganized balance sheet needs to properly assign deferred tax assets and deferred tax liabilities.

For each deferred tax account, there are four valuation methodologies:

  1. value the account as part of NOPLAT,
  2. value the account as part of a corresponding nonoperating asset or liability,
  3. value the account as a separate nonoperating asset, and
  4. ignore the account as an accounting convention.

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