Question

Medco has ebit of $1 million for the current year. on the firm's balance sheet, there is $5 million of debt outstanding that carries a coupon rate of 15 percent. if the firm faces a corporate tax rate of 40%, what is the present value of the firm's tax shields?

Answer 1

Tax shield for a company is the amount exempted from tax due to interest expense incurred by the company. Medco has earnings before interest and tax of $1million. Out of which, $5 million * 15% will be interest expense. Therefore, tax shield = 5 million * 0.15 * 0.4 = $300,000 (where 0.4 is the tax rate)