Question

LCMS Industries has​ $70 million in debt outstanding. The firm will pay only interest on this debt​ (the debt is​ perpetual). LCMS' marginal tax rate is​ 35% and the firm pays a rate of​ 8% interest on its debt.

Assuming that the risk of the tax shield is only​ 6% even though the loan pays​ 8%, then the present value of​ LCMS' interest tax shield is closest​ to:

Answer 1

Annual Tax shield = interest payment * tax rate

= $70,000,000 * 8% * 35% = $1,960,000

Present value of Interest tax shield = $70,000,000 * 0.35

= $24,500,000.

Present value of LCMs interest tax shield when risk of tax shield is 6%

= $70,000,000 * 0.35 * 0.08 / 0.06

= $32,666,666.67

or $32.67 million (rounded off to '2' decimals)

or $33 million (rounded off to Whole no.)