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?

Question

Quizplus · Accepted Answer

1. First, we need to calculate the annual interest payment:
Annual interest payment = Face value x Coupon rate = $5,000 x 12% = $600
2. Since the debt is perpetual, we need to calculate the present value of a perpetual annuity using the discount rate of 10%:
Present value of perpetual annuity = Annual interest payment / Discount rate = $600 / 0.10 = $6,000
3. Next, we need to calculate the present value of the tax shield by multiplying the present value of the perpetual annuity by the tax rate:
Present value of tax shield = Present value of perpetual annuity x Tax rate = $6,000 x 0.40 = $2,400
Therefore, the present value of the interest tax shield is $2,400, which is choice C.

Suppose a Vancouver ﬁRm Issues Perpetual Debt with a Face