Question

1. Braxton Enterprises currently has debt outstanding of $65 million and an interest rate of 10%. Braxton plans to reduce its debt by repaying $13 million in principal at the end of each year for the next five years. If? Braxton's marginal corporate tax rate is 35%?, what is the interest tax shield from? Braxton's debt in each of the next five? years?

2. Pelamed Pharmaceuticals had EBIT of $273 million in 2010. In? addition, Pelamed had interest expenses of $69 million and a corporate tax rate of 40%.

a. What is? Pelamed's 2010 net? income?

b. What is the total of? Pelamed's 2010 net income plus interest? payments?

c. If Pelamed had no interest? expenses, what would have been its 2010 net? income? How does it compare to your answer in part ?(a?)?

d. What is the amount of? Pelamed's interest tax shield in? 2010?

Answer 1

Question 1:

Interest tax shield for year 1 = 65,000,000 *0.10 *0.35 = 2,275,000

Interest tax shield for year 2 = 52,000,000 *0.10 *0.35 = 1,820,000

Interest tax shield for year 3 = 39,000,000 *0.10 *0.35 =1,365,000

Interest tax shield for year 4 = 26,000,000 *0.10 *0.35 =910,000

Interest tax shield for year 5 = 13,000,000 *0.10 *0.35 = 455,000

Question 2:

a. Net Income of Pelamed in 2010 = (EBIT - Interest)*(1-tax rate) = (273,000,000 - 69,000,000)*(1-0.4) = 122,400,000

b.Total of Pelamed's 2010 net income plus interest payment = 122,400,000 + 69,000,000 = 191,400,000

c. Net income of Pelamed if no interest = 273,000,000*(1-0.4) = 163,800,000. Net income would be higher when compared to part (a)

d. Interest tax shield in 2010 = 69,000,000 *0.4 = 27,600,000