If a firm issues an additional $1 million in debt at an interest rate of 12% and pays taxes at a marginal rate of 35%, the present value of the corporate income tax avoided, assuming the debt
Is perpetual is

Question

Quizplus · Accepted Answer

The present value of corporate income tax avoided can be calculated as follows:
PV of tax shield = interest rate x debt amount x tax rate
Since the debt is perpetual, we can use the perpetuity formula to calculate the present value:
PV of tax shield = (interest rate x debt amount) / cost of debt
Cost of debt = interest rate x (1 - tax rate)
Therefore, PV of tax shield = (0.12 x 1,000,000) / (0.12 x (1 - 0.35)) = $350,000.

If a Firm Issues an Additional $1 Million in Debt