Suppose a Vancouver firm issues perpetual debt with a face and market value of $5,000 and a coupon rate of 12%. If the firm is subject to a 40% tax rate and the appropriate discount rate is 10%, what is the present value of the interest tax shield?
A) $1,667
B) $2,000
C) $2,400
D) $3,600
E) $6,000

Question

Quizplus · Accepted Answer

The interest tax shield is calculated as the tax rate multiplied by the interest payment. The interest payment is $5,000 * 12% = $600. The tax shield is $600 * 40% = $240 per year. Since the debt is perpetual, the present value of the tax shield is $240 / 10% = $2,400.

Suppose a Vancouver Firm Issues Perpetual Debt with a Face