Question

1). If you had $1000 in a simple interest account paying an interest rate of 5% per period, how many periods would it take for the account balance to double?

2). Epsilon Enterprises has a total of $200,000 in long-term notes payable on the books, accruing interest at a rate of 12%. If the tax rate is 28%, how big of a tax shield does Epsilon Enterprises have?

Answer 1

1.When simple interest is applied, then interest is not earned on the interest amount. For simple interest, every period the interest amount would be same. When account balance doubles, it becomes $2000 out of which 2000-1000 = $1000 is due to interest

Simple Interest amount= Principal*rate*period

Or, 1000= 1000*0.05*period

Or period = 20

Thus, 20 periods are required.

2. Tax shield reduces the amount of taxes payable because interest on debt can be deducted before arriving at taxable income.

The interest expense = 0.12*200,000 = $24,000.

Tax shield each year = interest expense*tax rate = 24000*0.28 = $6,720.

Thus, tax shield each year is $6,720.