Question

Your firm currently has $ 100 million in debt outstanding with a 10 % interest rate. The terms of the loan require the firm to repay $ 25 million of the balance each year. Suppose that 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

$8.30 million approx

Step-by-step explanation:

The computation of the present value of the interest tax shield is shown below:

Year 0 1 2 3 4

Outstanding debt $100 million $75 million $50 million $25 million $0

Less: Interest $10 million $7.5 million $5 million $2.5 million

Less: Tax shield at 40% $4 million $3 million $2 million $1 million of interest

Discount factor at 10% 0.90909 0.82645 0.75131 0.68301

Present value $3.63 million $2.48 million $1.50 million $0.683 million

So, the present value is $8.30 million approx

The discount factor should be computed below

= 1 ÷ (1 + rate) ^ years