The Tax Cuts and Jobs Act of 2017 - Impact on Business, Asset, and Liability Valuations
The Tax Cuts and Jobs Act of 2017 (“TCJA”) will in general have an impact on business, asset, and liability valuations. The reduction in the federal corporate tax rate from 35% to 21% should increase free cash flow as a result of a lower federal tax burden for taxable C corporations; however, businesses conducted in “pass-through” forms have different after-tax dynamics due to other changes.
Some of the incremental value derived from an increase in cash flow will potentially be offset by a higher discount rate, or weighted average cost of capital (“WACC”). In calculating the weighted average cost of capital, the after-tax cost of debt will increase as a result of the lower tax rate. This assumes the same or similar capital structure for both debt and equity. While there are other nuances of the TCJA that will affect valuations, such as the inability to carryback corporate losses, the timing of cost recovery of capital expenditures and the 30% of EBITDA/EBIT limits of interest expense deductibility, the impact on the cash flows and discount rate are expected to have the most significant impact on value.
On a net basis, valuations should generally be higher as a result of the tax cut. Additionally, if non-US assets are a part of the bundle of assets being acquired, the new “deemed repatriation” rules are quite complex and affect immediate cash outflows, but are otherwise generally favorable when compared to pre-2018 law, and must be separately considered outside the basic rate decrease.