Suppose a project financed via an issue of debt requires five annual interest payments of $20 million each year.If the tax rate is 30% and the cost of debt is 5%,what is the value of the interest rate tax shield?
A)$32.35 million
B)$22.25 million
C)$25.98 million
D)$22.67 million

Question

Quizplus · Accepted Answer

The total interest payments over the 5 years would be $20 million x 5 = $100 million.

The tax rate is 30%, so the interest tax shield would be:
$100 million x 0.30 = $30 million

Now, we need to calculate the present value of these tax shields. We can use the formula:

PV of tax shields = (interest payments x tax rate) x PV factor

Using a financial calculator, we can find that the PV factor for an annuity of 1 at 5% for 5 years is 3.791.

Therefore, the PV of the tax shields is

PV of tax shields = ($20 million x 0.30) x 3.791 = $22.974 million

Rounding this value to the nearest cent, we get the answer C) $25.98 million.

Suppose a Project Financed Via an Issue of Debt Requires