Question

Your firm currently has 88 million in debt outstanding with a 9% interest rate, The terms of the loan require the firm to repay 22 million of the balance each year. Suppose that the marginal corporate tax rate is 40% and that the interest tax shields have the same risk as the loan. What is the present value of the interest tax shields from this debt.

The present value of this interest tax shield is

Answer 1

The tax shield would be 40% of the interest amount i.e (40% of 9%) of the outstanding debt = 3.6%

At the end of the first year, tax saving would be (3.6/100)*88= 3.168 million

At the end of the second year, tax saving would be (3.6/100)*66= 2.376 million( 22 million has been paid off hence calculated on the rest)

At the end of the third year, tax saving would be (3.6/100)*44= 1.584 million

At the end of the last year, tax saving would be (3.6/100)*22= 0.792 million

The present value factors for 9% over 4 years are 0.917, 0.842, 0.772, 0.708

Multiplying the respective tax shields with PV factors and adding them up, we get 6.68 million.