Tax Shield Choices: Pedagogical Application

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Hull, Robert M.
Washburn University. School of Business
Kaw Valley Bank
Issue Date
December 2022
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We offer a pedagogical application on the role of taxation on business decision-making that focuses on the value of a traditional interest tax shield (ITS) versus a retained earnings tax shield (RTS). This exercise demonstrates that an RTS serves to promote business growth, lower financial distress, and achieve greater equality in the taxation of different business ownership forms. A study of these two tax policies challenge students to understand the relevant tax shield factors that are essential in achieving optimal corporate finance and tax policy outcomes. In terms of maximizing firm value, students will learn that an ITS is inefficient and suboptimal compared to an RTS policy. Students also gain experiential knowledge and acquire skills on how to analyze an RTS in terms of understanding its role in maximizing firm value. By experiencing this exercise, students acquire important insights on how taxation policy can be detrimental or beneficial to business growth and what is needed to overcome barriers to achieve this growth. Finally, our instructional exercise supports teamwork learning and enables students to apply finance equations and enhance their Excel skills used in the business world.