Calculate the annual value of an interest tax shield under t

Calculate the annual value of an interest tax shield under the assumption that a firm maintains debt at a permanent $1,000,000 level and rate of 12 percent. The corporate tax rate is 35 percent. If there is no chance of financial distress, how does the value of the firm change as a result of this debt?

Solution

annual value of interest tax shield = debt * interest rate * corporte tax rate

=>$1,000,000 * 12% * 35%

=>$42,000.

annual value of tax sheild = $42,000.

If there is no chance of financial distress, the value of firm increases by present value of tax sheild

=> annual tax sheild / rate of debt.

=>$42,000 / 0.12

=>$350,000.

SO, the value of firm increases by $350,000 as a result of this debt.