Question

Establishment Industries borrows $760 million at an interest rate of 7.2%. Establishment will pay tax at an effective rate of 35%. What is the present value of interest tax shields if:

a. It expects to maintain this debt level into the far future? (Enter your answer in millions of dollars.)

b. It expects to repay the debt at the end of 4 years? (Enter your answer in millions of dollars rounded to 2 decimal places.)

c. It expects to maintain a constant debt ratio once it borrows the $760 million and rAssets = 10%? (Do not round intermediate calculations. Enter your answer in millions of dollars rounded to 1 decimal place.)

Answer 1

a. The present value of interest tax shields with the same debt level for far future will be Total Debt * Tax Rate = 760 * 35% = 266

b. If the debt is repaid at the end of 4 years, the present value of interest tax shields will be 4*(Annual Interest on debt) * Tax rate = 4 * (7.2% * 760) *35% = 76.61

c. If a constant debt ratio is maintained with rAssets=10%, the present value of interest tax shields will be

(Total Debt / (1-rAssets) ) *Tax Rate = 760 / (1-10%) * 35% = 295.6