Arnell Industries has $50 million in permanent debt outstanding. The firm will p

Question

Arnell Industries has $50 million in permanent debt outstanding. The firm will pay interest only on this debt. Arnell's marginal tax rate is expected to be 30% for the foreseeable future.

a. Suppose Arnell pays interest of 7% per year on its debt. What is its annual interest tax shield? $___ million (round to 3 decimal places)

b. What is the present value of the interest tax shield, assuming its risk is the same as the loan? $___ million (round to 1 decimal place)

c. Suppose instead the interest rate on the debt were 6%. What is the present value of the interest tax shield in this case? $___ million (round to 1 decimal place)

Explanation / Answer

a) Annual interest tax shield = Debt x Interest rate x tax rate

= 50m x 7% x 30%

= 1.050 million

b) PV = 1.050 / 7% = 15.0 million

c) PV = Debt x Tax rate = 30% x 50 = 15.0 million

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