Musings On Markets

In my last post, I looked at the unwanted effects on collateral value of the threat of authorities expropriation (nationalization). 30 million subsidy it acquired received from the German government. Governments, through the age range, have played favorites with businesses, either providing help to their preferred companies or, in some full cases, handicapping their competition. 1. “Low or no cost” funding: The cost of borrowing (debts) for a company should reflect its default risk. In some full cases, governments can step in the fray and either provide or assist in “cheap” or “below market rate” financing, ranging from grants or loans (effectively free financing) to low-interest rate loans (Airbus) to performing as a loan guarantor with banking institutions (Tesla).

The net effect is the same: the company can borrow more money at lower interest rates than it usually would have been able to, which, in turns, reduces its overall cost of funding its operations. You can claim that bailouts are a variant with this subsidy, insofar as it offers a financial lifeline to distressed (usually too-big-to-fail) firms that otherwise would have faced default.

2. Tax holidays, credits and deductions: The tax code has long been a favored device for the government to bestow benefits on chosen sectors or companies. A aspect notice: One oft-used proxy which businesses get subsidized the most is the difference between the effective tax rate paid by these lenders and the marginal tax rate. I survey the average effective tax rates on my website, by sector.

However, I believe that the dominant factor generating effective tax rates is not taxes subsidization but international sales now. The more revenues a company (or sector) generates from overseas (where corporate tax rates are lower), the low the effective taxes rate will be. 3. Revenue or price support (Higher and more predictable profits): In some instances, governments step in to both stabilize and increase revenues of businesses by providing price support to companies.

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For instance, the US government, amongst others, has provided price works with for a few agricultural products, such as glucose. In other instances, governments benefit companies by handicapping foreign competition and imposing tariffs on imported goods. Sometimes, federal government can indirectly support earnings by giving the subsidies to the customers of preferred companies; an example would be credits offered to homeowners for using solar panels on their houses. 4. Indirect subsidies: Instead of provide benefits directly to a company, the government can also drive competitors to maintain the business by either paying a cash subsidy to the company or by buying its products at an organized price.

There are two ways of coping with subsidies. One is to create them into your discounted cashflow valuation inputs and let them flow into your estimated value. The other is to ignore subsidies in a DCF valuation and also to value subsidies separately and add them on. Enter the subsidized cost of personal debt and/or the subsidized debts ratio into the price of capital, which will yield a lower cost of capital and higher value. Thus, if a firm like Tesla that normally wouldn’t normally have been able to borrow money, since it is a risky, money shedding company.