Bond Corp is a manufacturing firm with no debt outstanding. It is considering bo
ID: 2729432 • Letter: B
Question
Bond Corp is a manufacturing firm with no debt outstanding. It is considering borrowing $25 million at 8 percent and using the proceeds to buy back shares. Its equity market value is $100 million, and its profits are taxed at 35 percent.
a. What would be the present value of the interest tax shield if the debt is permanent? Write your answer in millions and round to two decimal points and EXPLAIN
b. What would be the present value of the interest tax shield if the interest rate increases to 9 percent immediately after the debt is issued? Write your answer in millions and round to two decimal points and EXPLAIN
Explanation / Answer
Annual interest payment = $25,000,000×8% = $2,000,000
Tax saving per year = $2,000,000×35% = $700,000
a)
Present value of interest tax shield:
= $700,000÷8%
= $8,750,000
b)
Present value of interest tax shield:
= $700,000÷9%
= $7,777,777.77