Compute the PV of the interest tax shields generated by the following three debt issues. In each case the debt is risk free while the corporate tax rate is 35%.
a) A $1,000 one-year loan at the risk-free rate of 8%.
b) A five-year loan of $1,000 at the risk-free rate of 8%. Assume interest is paid annually while the principal is paid back at maturity.
c) A $1,000 debt perpetuity at the risk-free rate of 7%.
Compute the PV of the interest tax shields generated by the following three debt issues. In each case the debt is risk free while the corporate tax rate is 35%.
a) A $1,000 one-year loan at the risk-free rate of 8%.
b) A five-year loan of $1,000 at the risk-free rate of 8%. Assume interest is paid annually while the principal is paid back at maturity.
c) A $1,000 debt perpetuity at the risk-free rate of 7%.
Related questions
| Compute the present value of interest tax shields generated by these three debt issues. Consider corporate taxes only. The marginal tax rate is Tc = 0.40. |
| a. | A $2,400, one-year loan at 7%.(Do not round intermediate calculations. Round your answer to 2 decimal places.) PV (tax shield)____________$ |
| b. | A three-year loan of $2,400 at 7%. Assume no principal is repaid until maturity. (Do not round intermediate calculations. Round your answer to 2 decimal places.) PV (tax shield)____________$ |
| c. | A $2,400 perpetuity at 6%. PV (tax shield)____________$ |
4. Raymond Supply, a national hardware chain, is considering purchasing a smaller chain, Strauss & Glazer Parts (SGP). Raymond's analysts project that the merger will result in the following incremental free cash flows, tax shields, and horizon values:
| Year | 1 | 2 | 3 | 4 |
| Free cash flow | $1 | $3 | $3 | $7 |
| Unlevered horizon value | 75 | |||
| Tax shield | 1 | 1 | 2 | 3 |
| Horizon value of tax shield | 32 |
Assume that all cash flows occur at the end of the year. SGP is currently financed with 30% debt at a rate of 10%. The acquisition would be made immediately, and if it is undertaken, SGP would retain its current $15 million of debt and issue enough new debt to continue at the 30% target level. The interest rate would remain the same. SGP's pre-merger beta is 2.0, and its post-merger tax rate would be 34%. The risk-free rate is 8% and the market risk premium is 4%. What is the value of SGP to Raymond?
