Question

Your firm currently has $ 104 million in debt outstanding with a 10 % interest rate. The terms of the loan require it to repay $ 26 million of the balance each year. Suppose 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?

Answer 1

Current debt 104 millions

Every year repayment 26 millions

Every year debt will reduced by $26 millions.

Interest tax shield formula = interest * Tax rate

Outstanding debt. interest@10% Tax shield @40% on int. P.V.F @10%. P.V. of tax shield

Year. 1. 104. 10.4 4.16 0.9090909091. 3.781818182

Year 2 78. 7.8 3.12 0.826446281 2.578512397

Year 3 52 5.2 2.08 0.7513148009. 1.562734786

Year 4 26. 2.6. 1.04 0.6830134554 0.7103339936

Total 8.633399358

So, present value of tax shield is $8.633 millions.

Note : P.V.F. formula = 1/(1+I)^n

like for 1 year 1/(1+0.10)^1

like for 1 year 1/(1+0.10)^2 and so on.