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Peter Corperations expects to have free cash flow in the coming year (FCF1) of $1.75 million,...

Peter Corperations expects to have free cash flow in the coming year (FCF1) of $1.75 million, and its FCF is expected to grow at a rate of 3.5% per year thereafter. Peter Coperations has a cost of equity of 12% and a cost of debt of 7%, and it pays a corporate tax rate of 40%. If Peter Coperations maintains a D/E ratio of 2.5, what is the value of its interest tax shield?

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Answer #1

Cost of debt is tax deductible. We need to calculate the price of the stock using before tax cost of debt and after tax cost of debt to calculate the value of tax shield.

We are given the D/E E ratio of 2.5 which implies that for every 1 unit of Equity, there are 2.5 units of Debt so total capital is D+E = 1+2.5=3.5

Using this we can calculate the before tax and after tax WACC

Now we can calculate the Before tax and after tax value of the company

So value of tax shield is 59.76-35.51 = 24.25 million

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