If a firm permanently borrows $50 million at an interest rate of 10 percent, what is the present value of the interest tax shield? Assume a 21 percent marginal corporate tax rate.
A)$50.0 million
B)$25.0 million
C)$10.5 million
D)$1.5 million

Question

Quizplus · Accepted Answer

The present value of the interest tax shield can be calculated as follows:

PV(interest tax shield) = TC x INT x PV

where:
TC = marginal corporate tax rate = 21%
INT = interest expense = $50 million x 10% = $5 million per year
PV = present value factor of the perpetuity

PV = INT / r

where:
r = cost of debt = 10%

PV = $5 million / 0.10 = $50 million

Therefore, the present value of the interest tax shield is:

PV(interest tax shield) = 0.21 x $5 million x $50 million = $10.5 million

Therefore, the best choice is C, $10.5 million.

If a Firm Permanently Borrows $50 Million at an Interest