This paper examines the effects of a tax loss carryover on the market and book values of

a firm’s assets. The loss carryover has a direct effect on market value by sheltering future

income from tax and a direct effect on book value due to the recognition of a deferred tax

asset. The failure to discount the deferred tax asset to its present value causes the marketto-

book ratio of the deferred tax asset to be less than one. However, positive skewness in

the distribution of future taxable income can cause the market-to-book ratio to exceed

one because the market value depends on the mean level of future tax benefits while the

book value is based on the median level of future tax benefits. The loss carryover also has

an indirect effect on firm value in that it induces the firm to exercise its real option to

invest early. This reduces firm value before investment takes place and decreases the

market-to-book ratio of physical assets after investment takes place.