If a firm borrows $50 million for one year at an interest rate of 10%,what is the present value of the interest tax shield? Assume a 30% marginal corporate tax rate.
A)$1.36 million
B)$1.50 million
C)$1.00 million
D)$4.55 million

Question

Quizplus · Accepted Answer

The present value of the interest tax shield is the present value of the tax savings that the firm will receive over the life of the loan. The tax savings are equal to the interest expense multiplied by the marginal corporate tax rate. In this case, the interest expense is $5 million (=$50 million * 10%) and the marginal corporate tax rate is 30%. Therefore, the tax savings are $1.5 million (=$5 million * 30%). The present value of the tax savings is the tax savings divided by the discount rate. In this case, the discount rate is 10%. Therefore, the present value of the tax savings is $1.36 million (=$1.5 million / 10%).

If a Firm Borrows $50 Million for One Year at an Interest