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12 August, 18:43

Assume the M&M with corporate taxes. The corporate tax rate is 40%. Your firm is currently unlevered with 100% equity. As of now, the value of the firm's equity is $400K, and the firm's cost of capital is 10%. Assume that your firm can borrow at 4% from a bank. Suppose that you decided to lever up by reducing equity and increasing debt. As the result, your firm now has $250K in debt. Your firm plans to maintain this debt amount forever. What is the present value of the interest tax shield? A. $40KB. $160KC. $80KD. $100K

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  1. 12 August, 20:24
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    D. $100 K

    Explanation:

    Data provided

    Debt = $250 K

    Corporate tax rate = 40%

    Corporate tax rate

    The computation of present value of the interest tax shield is shown below:-

    Present value of the interest tax shield = Debt * Corporate tax rate

    = $250 K * 40%

    = $100 K

    Therefore for computing the present value of the interest tax shield we simply multiply the debt with corporate tax rate.
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