Ford expects to earn a free cash flow of $100, starting in 1 year, forever. The

Question

Ford expects to earn a free cash flow of $100, starting in 1 year, forever. The discount rate on the assets of the firm is 18%. Further, Ford has issued debt of $1,000 at an interest rate of 5%. Ford will keep its Debt/Equity ratio fixed, so that as the firm does well (poorly), its level of debt will increase(decrease). The cost of debt and interest rate will remain at 5% no matter how much debt Ford raises. Finally, Ford has a tax rate of 30%. What is the present value of Ford’s interest tax shield?

a. 15

b. 83

c. 0

d. 300

Explanation / Answer

INTEREST TAX SHIELD = AMOUNT OF INTEREST X TAX RATE = (1000 X 5%) X 30% = 15

PRESENT VALUE OF INTEREST TAX SHIELD

= INTEREST TAX SHIELD/INTEREST RATE = 15/5% = 300

ANSWER : D : $300

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