Compute the present value of interest tax shields generated by these three debt

Question

Compute the present value of interest tax shields generated by these three debt issues. Consider corporate taxes only. The marginal tax rate is Tc = 0.40.  

a.

A $2,400, one-year loan at 7%.(Do not round intermediate calculations. Round your answer to 2 decimal places.)

PV (tax shield)____________$

b.

A three-year loan of $2,400 at 7%. Assume no principal is repaid until maturity. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

PV (tax shield)____________$

c.

A $2,400 perpetuity at 6%.

PV (tax shield)____________$

Compute the present value of interest tax shields generated by these three debt issues. Consider corporate taxes only. The marginal tax rate is Tc = 0.40.  

Explanation / Answer

Answer-1

Interest=2400*.07=$168

kD=7*.6=4.20%

Tax Saving=$168*.40=$67.20

PV of Tax Shield=$67.20*.959=$64.44

Answer 2-

3-Interest=2400*.06=$144

Tax Shield=144*.4=$57.60

PV of Tax shield=$57.60/.036=$1600

Year 1 Year 2 Year 3 Interest $                 168.00 $              168.00 $        168.00 Tax @40% $                   67.20 $                 67.20 $          67.20 PVF @4.2% $                      0.96 $                   0.92 $            0.88 Present Value $                   64.44 $                 61.89 $          59.34 Total PV $                 185.67

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