Question

Assume the M&M with corporate taxes. The corporate tax rate is 40%. Your firm is currently unlevered with 100% equity. As of now, the value of the firm’s equity is $400K, and the firm’s cost of capital is 10%. Assume that your firm can borrow at 4% from a bank.Suppose that you decided to lever up by reducing equity and increasing debt. As the result, your firm now has $250K in debt. Your firm plans to maintain this debt amount forever. What is the present value of the interest tax shield?A. $40KB. $160KC. $80KD. $100K

Answer 1

D. $100 K

Step-by-step explanation:

Data provided

Debt = $250 K

Corporate tax rate = 40%

Corporate tax rate

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

Present value of the interest tax shield = Debt × Corporate tax rate

= $250 K × 40%

= $100 K

Therefore for computing the present value of the interest tax shield we simply multiply the debt with corporate tax rate.