Question

Models and More has a bond issue outstanding with a face value of $215,000. These bonds have a coupon rate of 5.65 percent, pay interest semiannually, and have a current market price quote of 1.01. The tax rate is 34 percent. What is the amount of the annual interest tax shield?

Answer 1

Solution :

1. Annual interest on the bond = Face value of the bond * Coupon rate

                                               =$ 215,000 * 5.65 % = $ 12,147.5

2. Annual Interest tax shield = Interest amount * tax rate

   = $ 12,147.5 * 34 % = $ 4,130.15 = $ 4,130          

Interest is a Tax deductible expense. Thus the total taxable income of Models & More is reduced by the interest paid amount of $ 12,147.5.

This results in a tax saving of $ 12,147.5 * 34 % = $ 4,130 = Annual tax shield.