Question

Wyatt Oil issued $100 million in perpetual debt (at par) with an annual coupon of 7%. Wyatt will pay interest only on this debt. Wyatt's corporate tax rate is expected to be 21% for the foreseeable future. The present value of Wyatt's annual interest tax shield is closest to $___________million.

• A. 4.2
• B. 7
• C. 21
• D. 60

Assume that five years have passed since Wyatt issued this debt. While tax rates have remained at 21%, interest rates have dropped so that Wyatt's current cost of debt capital is now only 4%. The present value of Wyatt's annual interest tax shield is now closest to $_________ million.

• A. 2.8
• B. 36.8
• C. 60.0
• D. 70.0

Answer 1

The present value is computed as shown below:

= ( Annual coupon rate x $ 100 million x tax rate ) / Annual coupon rate

= ( 7% x $ 100 million x 21% ) / 7%

= $ 21 million

So, the correct answer is option c

The present value is computed as shown below:

= ( Annual coupon rate x $ 100 million x tax rate ) / cost of debt capital

= ( 7% x $ 100 million x 21% ) / 4%

= $ 36.8 million Approximately

So, the correct answer is option b i.e. $ 36.8

Feel free to ask in case of any query relating to this question