Establishment Industries borrows $890 million at an interest rate of 8.5%. Estab

Question

Establishment Industries borrows $890 million at an interest rate of 8.5%. Establishment will pay tax at an effective rate of 35%. What is the present value of interest tax shields if: a. It expects to maintain this debt level into the far future? (Enter your answer in millions of dollars rounded to 1 decimal place.)

Present value $_____ million

b. It expects to repay the debt at the end of 5 years? (Enter your answer in millions of dollars rounded to 2 decimal places.) Present value $ ________million

c.It expects to maintain a constant debt ratio once it borrows the $890 million and rAssets = 10%? (Do not round intermediate calculations. Enter your answer in millions of dollars rounded to 2 decimal places.) Present value $ ____ million

Explanation / Answer

a) As it is a perpetuity, PV of interest tax shield = Tax rate x Debt = 890 x 35% = $311.50 million

b) In this case, annual interest payment = 8.5% x 890 = 75.65 million

PV of interest payment for 5 years can be calculated using PV function

N = 5, I/Y = 8.5%, PMT = 75.65, FV = 0 => Compute PV = $298.11 million

PV of interest taxshield = 35% x 298.11 = $104.34 million

c) In this case, PV of interest tax shield = Tax rate x Debt x Interest rate / rAssets

= 35% x 890 x 8.5% / 10%

= $264.78 million

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