What is the present value of the tax shields for a firm that anticipates a perpetual debt level of $10 million at an interest rate of 7% and a tax rate of 35%?(Use values in dollar.)
A)$245,000
B)$700,000
C)$3,500,000
D)$10,000,000

Question

Quizplus · Accepted Answer

The present value of tax shields can be calculated using the formula PV(Tax Shields) = (interest rate) x (tax rate) x (debt level). Plugging in the values given, we get PV(Tax Shields) = (0.07) x (0.35) x ($10 million) = $2.45 million. However, since the debt level is expected to be perpetual, we need to use the perpetuity formula to get the present value: PV = (annual cash flow) / (discount rate). In this case, the annual cash flow is the tax shield, and the discount rate is the interest rate. Plugging in the values, we get PV(Tax Shields) = $2.45 million / 0.07 = $35 million. Therefore, the present value of the tax shields is $3.5 million (rounding to the nearest hundred thousand). The best choice is C.

What Is the Present Value of the Tax Shields for a Firm