Question

Bay Transport Systems (BTS) currently has $25 million in debt outstanding. In addition to 7.5% interest, it plans to repay 4% of the remaining balance each year. If BTS has a marginal corporate tax rate of 21%, and if the interest tax shields have the same risk as the loan, what is the present value of the interest tax shield from the debt? The present value is $ million. (Round to two decimal places.)

Answer 1

Interest rate tax shield in year 1= $25 million*7.5%*21%= $0.3938 million 0.39 million.

We are valuing the interest rate tax shield as a growing perpetuity with growth rate of -4% and interest rate equal to 7.5%.

The present value of growing perpetuity is calculated using the below formula:

Present value of growing perpetuity= Payment at year 1/ Interest rate- growth rate

                                                                     = $0.39 million/ 7.5 + 4

                                                                     = $0.39/ 0.1150

                                                                     = 3.3913 million   3.39 million.

Therefore, the present value of the interest rate tax shield is $3.39 million.

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