Question

Whispering Pines, a recovery center for Mountain Dew addicts, has a perpetual level of debt of $50 million and an equal amount of equity. Assuming the firm has a rate of debt of 7.5% and the corporate tax rate is 30%, what is the value (today) of the tax shield provided by Whispering Pines’ debt?

Answer 1

Answer:

$1,125,000

Explanation:

Tax Shield is the saving of tax due some allowable deduction. In this question the cost of debt is the allowable deduction that cause the tax saving.

As per given data

Debt value = $50 million = $50,000,000

Cost of Debt = 7.5%

Interest on debt = Debt value x Cost of debt

Interest on debt = $50,000,000 x 7.5%

Interest on debt = $3,750,000

Tax shield on the interest expense = Interest expense x Tax rate

Tax shield on the interest expense = $3,750,000 x 30%

Tax shield on the interest expense = $1,125,000