Investment and financing decision models under the imputation tax system
The aim of this thesis it to explore the effects of the imputation tax system on the relationships between corporate investment and financing decision variables. Under the Capital Asset Pricing Model it is shown that except with instantaneous relief for capital expenditure at 100 per cent, the present system of capital allowances may reduce the expected return to an amount below that required by the post-tax level of risk. A complex equation is derived to show the relationship in partial equilibrium between the after-tax valuation of the levered firm and that of an equity financed firm of equivalent operating risk. This includes the effects of income tax, capital gains tax, corporation tax and risky debt. Sufficient conditions for a neutral tax system are found although these are shown to be violated in practice, with a general preference for debt finance rather than new issues of shares. In general equilibrium capital structure is found to be irrelevant under the UK tax system. For the partial equilibrium model however even in a world of certainty it is shown that the borrowing versus retention decision is complex. It is observed that financial policies may vary over time and are sensitive to the effects of capital investment decisions on (i) Advance Corporation Tax set off restrictions, (ii) debenture interest carried forward and (iii) the marginal tax rate at which debenture interest is relieved. In turn capital investment decisions are shown to be sensitive to financial decisions in a market which is perfect apart from tax complexities. To accommodate both the peculiarities of the tax rules and the simultaneous solution of investment and financing decisions, a mathematical programming model is presented although it isnoted that in practice it could be difficult to solve.