This is anotherreason for shiftingto marginaltax
rates in future periods.- Ifwebasetheprojectionsonthereportedincome,we
willoverstateexpectedfutureincome.Theeffecton
cash flows is likely to be muted. To see why,
consider one very common difference between
reportingandtaxincome:Straightlinedepreciationis
used to compute the former and accelerated
depreciation is used for the latter. Since we add
depreciationbacktoafter-taxincometogettocash
flows,thedropindepreciationwilloffsettheincrease
in earnings. The problem, however, is that we
understate the tax benefits from depreciation. - Some companies capitalize expenses for reporting
purposes (and depreciating them in subsequent
periods) but expense them for tax purposes. Here
again,usingtheincomeandthecapitalexpenditures
fromreportingbookswillresultinanunderstatement
of the tax benefits from the expensing.
Thus, the problems created by firms having different
standardsfortaxandaccountingpurposesaremuchgreaterif
wefocusonreportedearnings(asisthecasewhenweuse
earningsmultiples)thanwhenweusecashflows.Ifwehave
achoice,however,wewouldbaseourvaluationsonthetax
books rather than the reporting books.
Dealing with Tax Subsidies and Credits
Firmssometimes obtaintaxsubsidiesfromthegovernment
forinvestinginspecifiedareasortypesofbusinesses.These
taxsubsidiescantaketheformofeitherreducedtaxratesor
taxcredits.Either way,thesesubsidies shouldincrease the