Is a Detailed Tax Planning for Investment Decisions Worthwhile? Evidence from Germany

22 Pages Posted: 15 May 2006

See all articles by Deborah Schanz

Deborah Schanz

Ludwig Maximilian University of Munich - Faculty of Business Administration (Munich School of Management)

Date Written: May 2006

Abstract

Real-world tax systems distort investment and financing decisions. Therefore, taxes are integrated into capital budgeting models. However, these models use very simplified tax bases. Investors typically assume tax bases to be equal to cash flows less depreciation allowances. We analyse the investment incentives resulting from such a simplified tax planning. The analysis is based on a stochastic business simulation model applying empirical data from different industries. Using Monte Carlo simulations, we cover a wide variety of business developments.

We show that using cash flows minus depreciation allowances as a tax base generates deviations compared to investment planning with a detailed tax base in accordance with current tax laws. The anticipated NPVs or future values of companies can be too high or too low, depending on the company's legal structure and industry. Using only cash flows as a tax base leads to an anticipated future value which is always too high.

But these deviations are small compared to incorrect forecasts of interest rates or tax rates. For example, if the income tax is reduced to 37%, while the anticipated tax rate is 42%, or if the interest rate increases by 3 percent points, the future value and the deviation are much higher compared to tax base-induced deviations.

Hence, investors should pay more attention to the forecast of interest rates and tax rates, as opposed to reproducing a more detailed tax base of investment projects.

Keywords: Taxes, investment decision, capital budgeting

Suggested Citation

Schanz, Deborah, Is a Detailed Tax Planning for Investment Decisions Worthwhile? Evidence from Germany (May 2006). Available at SSRN: https://ssrn.com/abstract=901381 or http://dx.doi.org/10.2139/ssrn.901381

Deborah Schanz (Contact Author)

Ludwig Maximilian University of Munich - Faculty of Business Administration (Munich School of Management) ( email )

Ludwigstr. 28 RG IV
Munich, Bavaria 80539
Germany
+49 (0) 89 / 2180 - 3681 (Phone)
+49 (0) 89 / 2180 - 3874 (Fax)

HOME PAGE: http://www.en.steuern.bwl.uni-muenchen.de/index.html

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