Box Inc. has raised $10 million by issuing perpetual debt at par (i.e., face value is equal to the value of the debt). The interest on this debt is the only interest the firm will pay. The marginal tax rate of Box Inc. is expected to be 40% (corporate tax is the only tax the company has to pay):

a) Suppose Box Inc. pays an interest of 5% per year on its debt. What is its annual debt tax shield?
b) What is the present value of the interest tax shield? (Assume that the discount rate is the same as the interest rate on the debt.)
c) If the interest rate on the debt was 10% instead of 5%, what would be the present value of the interest tax shield?
d) [for class presentation only] Suppose now that the government passes a new law which means that companies have to pay corporate tax on interest payments (i.e., interest is no longer deducted from taxable income)? What is the value of the tax shield now?

Answer rating: 100% (QA)

a The annual debt tax shield is equal to the amount of interest paid multiplied by the marginal tax ... View the full answer