Question

Establishment Industries borrows $750 million at an interest rate of 7.1%. Establishment will pay tax at an effective rate of 21%. What is the present value of interest tax shields if:

a. It expects to maintain this debt level into the far future? (Enter your answer in millions of dollars rounded to 1 decimal place.)

b. It expects to repay the debt at the end of 5 years?  (Do not round intermediate calculations. Enter your answer in millions of dollars rounded to 2 decimal places.)

c. It expects to maintain a constant debt ratio once it borrows the $750 million and r_Assets = 10%? (Do not round intermediate calculations. Enter your answer in millions of dollars rounded to 1 decimal place.)

Answer 1

a)
Present value of tax shield = Borrowed amount * tax rate
= $750 million * 21%
= $157.5 million

b)

Annual tax shield = (Borrowed amount * interest rate) * tax rate
= ($750 million * 7.1%) * 21%
= $53.25 million * 21%
= $11.1825 million

Present value of tax shield = C × [1-(1+r)^-n]/r
= $11.1825 million * (1-(1+0.071)^(-5)) / 0.071
= $11.1825 * 4.0892
= $45.73 million

Present value of tax shield = $45.73 million

c)

Present value of tax shield = Annual tax shield / interest rate
= $11.1825 million / 10%
= $111.8 million