Question

Rappaport Industries has 5,950 perpetual bonds outstanding with a face value of $2,000 each. The bonds have a coupon rate of 6.2 percent and a yield to maturity of 6.5 percent. The tax rate is 40 percent. What is the present value of the interest tax shield?

Answer #1

Interest payment per perpetual bond per year = Face value * Coupon rate

Interest payment per perpetual bond per year = $2000*0.062 = $124

Total Interest payment per year = 5950*124 = $737,800

Total tax-shield per year = Total Interest payment per year* Tax rate

Total tax-shield per year = $737,800*0.4 = $295,120

PV of interest tax shield = Total tax-shield per year / Yield to maturity

PV of interest tax shield = 295,120/0.065

PV of interest tax shield = $4,540,307.69

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