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

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