Compute the present value of interest tax shields generated by these three debt
ID: 2645807 • Letter: C
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 $1,200, one-year loan at 9%.(Do not round intermediate calculations. Round your answer to 2 decimal places.)
A seven-year loan of $1,200 at 9%. Assume no principal is repaid until maturity. (Do not round intermediate calculations. Round your answer to 2 decimal places.)
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:
Tax Shield means the saving in tax due to tax deductible expense here Ineterst expense is tax deductible expense so tax shield shall be interest cost * tax rate and then we shall calculate PV.
(a) Interest Expense = $1200*9% = $108
Tax Shield = $108 * 0.40 = $43.2
Discount rate = 9% = 0.09
Hence Present value of tax shield = $43.20 /(1+ 0.09) = $39.63
(b) Annual interest = $1200*9% = $108
Annual Tax Shield = $108 * 0.40 = $43.2
Discount rate = 9%=0.09
Using the formula: Present value of annuity = P* [{1-(1+r)^(-n)}/r]
P =Annual Tax Shield = $108 * 0.40 = $43.2
r= Discount rate = 9%=0.09
n= Years = 7
Hence Present value of tax shield
= 43.2 *[{1-(1+0.09)^(-7)}/0.09]
= $217.42
(c) Annual interest = $1200*8% = $96
Annual Tax Shield = $96 * 0.40 = $38.40
Discount rate = 8%=0.08
Hence Present value of tax shield (Perpetuity) = $38.40 / 0.08 = $480
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