should you choose?
Let's start with what you cannot
use - the actual taxes paid. Why not? The actual taxes paid will
reflect the fact that you save on taxes when you make interest
payments. The problem, however, is that you have already counted
the tax benefits in your cost of capital (by using the after-tax
cost of debt) and increasing your cashflow for the same reason
would be double counting.
It boils down to a choice between
effective and marginal tax rates. The effective tax rate is lower
than the marginal tax rate for a number of reasons but one reason
is that companies defer paying taxes. Since this is a tax saving,
there is nothing wrong with using the effective tax rate in computing
the after-tax operating income for last year and even for the
next few years. If you use it forever, though, you are assuming
that you can defer taxes in perpetuity and that is a dangerous
assumption. The best compromise is to use effective tax rates
for the early forecast years and move towards a marginal tax
rate in the later years.
if you are a multinational and are in several countries with very
different tax rates?
While some would push for an average
tax rate, weighted by the income in each country, I think it
makes far more sense to use the marginal tax rate of the country
the company is domiciled in as a floor. After all, income earned
in countries with lower tax rates than the domestic tax rate
eventually has to be repatriated back to the domicile at which
point it will be taxed. It is a tougher call for countries with
higher marginal tax rates than the domestic tax rate. Here, it
does make sense to use a weighted average.
happens if you are reporting an operating loss?
In the year
of the operating loss, the tax rate used in computing the after-tax
operating income and the after-tax rate cost of debt should be
zero. As you project the earnings into future years and they turn
positive, you first have to cover your net operating losses from
prior years, during which period your tax rate will still be zero.
When you use up your net operating losses, your tax rate will converge
on the marginal tax rate.