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Matching Loan Cash Flows to WACC’s Tax Treatment

Article Quant Q&A · Author: PBD10017
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Summary

The document raises a valuation question about estimating the price of a privately traded loan portfolio when comparable market prices are unavailable. It notes that the weighted average cost of capital formula shown includes an after-tax cost of debt, then asks whether forecast interest received on the loans should also be reduced for corporate taxes before discounting.

The central issue is consistency between the tax basis of projected cash flows and the discount rate. The text poses the question but provides no answer, calculation, or valuation evidence, so it does not establish whether the interest cash flows should be adjusted in the described case. Actual treatment depends on the relevant tax and valuation assumptions, which are not supplied. It is therefore a useful framing of an enterprise valuation issue, rather than a complete method for pricing loan portfolios.

Key ideas

  • The question concerns valuing a loan portfolio without publicly observable transaction prices.
  • The stated WACC formula incorporates a tax adjustment to the cost of debt.
  • The document asks whether interest income forecasts should also reflect corporate taxes.
  • No answer or worked valuation is provided, so the appropriate cash flow treatment remains unresolved.

Tags

Fixed incomeRisk management
Full text
# Should cash-flows discounted at WACC be pre- or post-tax?


# Should cash-flows discounted at WACC be pre- or post-tax?












WACC in my mind is effectively a post-tax measure: $$\text{WACC} = \frac{E}{V} k_e+\frac{D}{V}k_d(1-t)$$ In this case should cash-flows, in particular loan cash-flows be adjusted for tax as well? Imagine a scenario where a company buys a portfolio of loans. The company is trying to estimate whether to buy the portfolio and for how much. Market approach is not feasible as these transactions do not have publicly available prices, the portfolio is very specific. Question is whether the cash-flows, interest cash flows specifically should be adjusted for the corporate tax rate $t$ by adjusting the total interest payment received $I$ by $(1-t)$ reflecting the fact that the company will have to pay taxes on interest received.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.