A firm has the following book-value balance sheet; Debt =$ 9 ,000, Common Stock

Question

A firm has the following book-value balance sheet; Debt =$ 9 ,000, Common Stock ($1 par)= 7 and Retained Earnings = $ 10 ,000. The book value of assets is the total of Debt, Common Stock and Retained Earnings. The firm's bonds are currently selling at par and the firm's stock is currently selling for $ 21 . The firm's tax rate is 36 %. What is the value of the firm's tax shield (i.e. the change in firm value due to the use of leverage in the capital structure)? Show your answer to the nearest $1. Do not use commas or the $ sign in your answer.

Explanation / Answer

Value of tax shield = Value of debt × Tax rate

= $9,000 × 36%

= $3,240

Value of tax shield is $3,240.

So, if firm use of leverage in the capital structure then its value increase by $3,240.

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