Question

Arnell Industries has just issued

$ 35$35

million in debt​ (at par). The firm will pay interest only on this debt.​ Arnell's marginal tax rate is expected to be

40 %40%

for the foreseeable future. a. Suppose Arnell pays interest of

8 %8%

per year on its debt. What is its annual interest tax​ shield?

b. What is the present value of the interest tax​ shield, assuming its risk is the same as the​ loan?

c. Suppose instead that the interest rate on the debt is

6 %6%.

What is the present value of the interest tax shield in this​ case?

a. Suppose Arnell pays interest of

8 %8%

per year on its debt. What is its annual interest tax​ shiel

Answer 1

a. Suppose Arnell pays interest of 8% per year on its debt. What is its annual interest tax​ shield?

Annual interest tax​ shield = Annual Interest * Tax rate

Annual interest tax​ shield = 35000000 * 8% * 40%

Annual interest tax​ shield = $1120000

b. What is the present value of the interest tax​ shield, assuming its risk is the same as the​ loan?

Present Value of Tax Shield = Annual Interest tax Shield / Interest Rate

Present Value of Tax Shield = $1120000 / 8%

Present Value of Interest Tax Shield = $14000000

c. Suppose instead that the interest rate on the debt is 6%. What is the present value of the interest tax shield in this​case?

Present value of the interest tax shield = Debt * Tax Rate

Present value of the interest tax shield = $35000000 * 40%

Present value of the interest tax shield = $14000000