A firm has interest expense of $2 500 each year for 10 years. If the tax rate is 30% and the discount rate is 7%, compute the value of the interest rate tax shield.
A)$5 744
B)$5 268
C)$5 918
D)$6 987

Question

Quizplus · Accepted Answer

To calculate the value of the interest rate tax shield, we use the formula:

Interest rate tax shield = Interest expense x Tax rate

In this case, the interest expense is $2,500 and the tax rate is 30%, so:

Interest rate tax shield = $2,500 x 0.3 = $750

Now, we need to calculate the present value of this tax shield for the 10 years using the discount rate of 7%. We can use the formula:

Present value = Tax shield / (1 + Discount rate)^n

where n is the number of years.

So, the present value of the tax shield is:

Present value = $750 / (1 + 0.07)^10
Present value = $5,268.06

Therefore, the best choice is B, with a present value of $5,268.

A Firm Has Interest Expense of $2 500 Each Year