Question

This year, Crystal Inn Hotel has a perpetual debt of $10 million. Assume the interest rate is 7%, and the tax rate is 21%, then what is the present value of the interest tax shield? $10,000,000 $245,000 $700,000 $2,100,000 > A Moving to another question will save this response. << < Question 24 of 30 > >>

Answer 1

Solution: Interest Tax Shield is the saving in the taxes due to the presence of debt which leads to a reduction in the income due to interest payments.

Interest Tax Shield for a year = Interest Rate*Tax Rate*Debt amount = KD*T*D

Interest Rate (Kd) = 7%

Tax Rate (T) = 21%

Debt Amount (D) = $10,000,000

Hence, Interest Tax Shield for a year = 7%*21%*10,000,000 = 147,000

Since debt is perpetual in nature, hence, Interest Tax Shield will be provided each year, assuming the tax rate and interest rate remains same

Present Value of a interest tax shield due to perpetual debt, PV(TS) = T*Kd*D/Kd = T*D

PV(TS) = 21%*10,000,000 = 2,100,000

Thus, Present Value of a interest tax shield due to perpetual debt = $2,100,000

Hence, the answer is (D)