ECB borrows $2 billion dollars by issuing 10 year bonds. ECB cost of debt is 6%
ID: 2643516 • Letter: E
Question
ECB borrows $2 billion dollars by issuing 10 year bonds. ECB cost of debt is 6% so it will need to pay $120M in interest each year for 10 years, and the, and repay the principal $2B in year 10. ECB's marginal tax rate will remain 35% throughout this period.A) By how much does the interest tax shield increase the value of ECB.
ECB borrows $2 billion dollars by issuing 10 year bonds. ECB cost of debt is 6% so it will need to pay $120M in interest each year for 10 years, and the, and repay the principal $2B in year 10. ECB's marginal tax rate will remain 35% throughout this period.
A) By how much does the interest tax shield increase the value of ECB.
A) By how much does the interest tax shield increase the value of ECB.
Explanation / Answer
Tax saving on interest = Interest * Tax Rate = $120million * 35% = $42million
Net outflow on account of interest
= Interest - Tax saved on interest
= $120million - $42million
= $78million
The value of the bond will increase as the cash outflow has reduced for every year. Using appropriate rate to discount the bond, the value of debt can be figured out.
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