Question

Arnell Industries has $35 million in permanent debt outstanding. The firm will pay interest only on this debt. Arnell's marginal tax rate is expected to be 30% for the foreseeable future. a. Suppose Arnell pays interest of 9% per year on its debt. What is its annual interest tax shield? b. What is the present value of the interest tax shield, assuming its risk is the same as the loan? c. Suppose instead the interest rate on the debt were 7%. What is the present value of the interest tax shield in this case?

Answer 1

a. Annual Interest tax shield = Debt * Interest * Tax Rate

Annual Interest tax shield = $35 million *9% *30%

Annual Interest tax shield = $0.945 million

b. PV of tax shield = $35 million *9% *30% / 9%

PV of tax shield = $10.50 million

c. PV of tax shield at 7% = 35million *7% *30% / 7%

PV of tax shield at 7% = $10.50 million