Answer:
a) $0.5145 million
b) $7.35 million
Explanation:
Given:
Permanent debt outstanding = $35,000,000
Expected marginal tax rate = 21%
a) Suppose they pay an interest of 7% per year on debt. Find the annual interest tax shield.
To find annual interes tax shield use the formula below:
Annual interest tax shield =Total par value of Debt × interest rate × tax rate
= $35,000,000 × 7% × 21%
= $35,000,000 × 0.07 × 0.21
= $514,500
Annual interest tax shield = $0.5145 million
b) What is the present value of the interest tax shield, assuming its risk is the same as the loan?
Use the formula:
Present value of the interest tax shield = Annual interest tax shield /loan interest rate
= $514,500 / 7%
= $7,350,000
present value of the interest tax shield = $7.35 million
