Ifweusethesedifferentpretaxcostsofdebtincomputingthe
operating costof capital,thevaluesof equityareidentical
usingboth thegrossdebtand netdebtapproaches undera
zero tax rate assumption.
Thesecondfactoristhatthenetdebtapproachnullifiesthe
taxadvantagethatyoureceiveonthedebtusedtofundcash,
whereasthegrossdebtapproachpreservesthetaxadvantage
on all debt, even if it is used to fund cash.
19 Asthetaxrateincreases,thisdifferencebetweenthetwo
valuationswillincrease.Thebottomlineisthatthedifference
in valuesbetween thetwo approacheswillincrease as tax
ratesandthedefaultriskincrease.Astowhichoneyieldsthe
betterestimateofvalue,weremainundecided.Thenetdebt
approachmakesthemorerealisticassumptionaboutthetax
advantageofdebtbeingcanceledoutbythetaxliabilityon
the income from cash. However, the net debt ratio can
become negative (if cash exceeds debt)
20 and shifting cash balances over time can add to its
volatility.Onbalance,weareinclinedtousethegrossdebt
approachtovalueoperatingassetsandkeepcashasaseparate
asset.
Should You Ever Discount Cash?
Ingeneral,wewouldarguethatadollarin cashshouldbe
valuedatadollarandthatnodiscountsandpremiumsshould
be attached to cash, at leastin thecontext of an intrinsic
valuation.Therearetwoplausiblescenarioswherecashmay