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 thiscase?

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**

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