Final answer:
The present value of the interest tax shield for Appaport Industries' perpetual bonds is calculated by taking the tax savings on the bond interest and discounting it into perpetuity. Assuming a perpetual bond interest rate of 8%, the present value of the tax shield is found to be $2,650,000.
Step-by-step explanation:
The student has asked for the present value of the interest tax shield for Appaport Industries' bonds. To calculate this, we need to find the annual tax savings due to interest expense which equals the bond interest times the corporate tax rate. Then, since the bonds are perpetual, we discount this annual tax savings into perpetuity using the formula PV = Tax Shield per Period / Discount Rate.
To proceed with the given information: Appaport Industries has 5,300 bonds at $2,000 each, implying a total debt of $10,600,000. Assuming an interest rate is not provided, we use the discount rate detailed in the reference, 8% – similar to the bond's interest rate. Each bond would contribute interest tax shield annually, which would be Bond's Interest * Tax Rate. Since the bonds are perpetual and there is no growth rate, we simply divide the tax shield by the discount rate.
Let's assume the interest rate on the bonds is the same as the given rate of 8%. The annual interest per bond is thus $2,000 * 8%, which is $160. The total annual interest would be $160 * 5,300 bonds, which is $848,000. The tax shield per year would be $848,000 * 25%, which equals $212,000. The present value of the perpetual interest tax shield would then be $212,000 / 0.08, which is $2,650,000.
The correct option answer for the present value of the interest tax shield is $2,650,000.