Question

biliiy's is currently an all equity firm. The firm has decided to leverage its operations by issuing $120,000 of debt at an interest rate of 9.5 percent. If the tax rate is 21%, how much is the present value of the interest tax shield effect?

$45,925

$38,475

$22,393

$25,200

Answer 1

Considering that the debt issued will continue forever. so the gain from the tax shield will be in perpetuity.

Gain from Tax Shield = Total Debt Issued* Interest Rate * Tax rate

= 120,000 * 9.5% * 21%

= 2394

So a saving od $2,394 will last forever. The present value of the gain can be found using an annuity.

Present Value = 2394 / Interest rate

= 2394 / 0.095

= 25,200

So the correct option is the last one

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