In
Part 1, the concept and rationale of tax affecting was
discussed. Tax affecting the earnings is considered necessary to
match the derived discount or capitalization rate to the definition
of economic income being discounted.
This arises frequently with entities that do not pay taxes at
the entity level, but rather pass the income and tax attributes out
to the equity holders. The usual examples involve pass-through
entities (PTEs), including partnerships, limited liability
companies and S corporations.
In establishing a discount or capitalization rate to apply to
cash flows or economic benefits, the data generally is reflective
of public corporations and are based on returns after the payment
of the corporate-level income taxes. However, if the entity is not
subject to tax then this has the effect of applying an after-tax
rate of return to pre-tax economic income. Shannon Pratt, a
well-known authority in the field of business valuation, considers
such an
