A firm plans to issue $1 million worth of debt at an YTM of 9%. The debt is trading at par. The firm's marginal corporate tax rate is 35%. What is the present value of the tax savings in perpetuity?
A) $11,025
B) $20,475
C) $350,000
D) $227,500

Question

Quizplus · Accepted Answer

The present value of the tax savings in perpetuity can be calculated using the formula:
PV of Tax savings = Marginal Tax Rate x Interest expense
where Interest expense = Debt amount x YTM = $1 million x 9% = $90,000

Therefore, PV of Tax savings = 35% x $90,000 = $31,500
Since the debt is trading at par, the present value of the tax savings is equal to the face value, which is $1 million x 35% = $350,000. Hence, option C is the correct answer.

A Firm Plans to Issue $1 Million Worth of Debt