BBA Ltd has just issued $10 million in debt (at par or face value). The firm will pay interest only on this debt. BBA’s marginal tax rate is expected to be 30% for the foreseeable future. a) Suppose BBA pays interest of 6% per year on its debt. What is its annual interest tax shield? b) What is the present value of the interest tax shield, assuming the tax shield’s risk is the same as that of the loan? c) Suppose instead that the interest rate on the debt is 5%. What is the present value of the interest tax shield in this case?

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
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BBA Ltd has just issued $10 million in debt (at par or face value). The firm will pay interest only on this debt. BBA’s marginal tax rate is expected to be 30% for the foreseeable future.

  1. a) Suppose BBA pays interest of 6% per year on its debt. What is its annual interest tax shield?
  2. b) What is the present value of the interest tax shield, assuming the tax shield’s risk is the same as that of the loan?
  3. c) Suppose instead that the interest rate on the debt is 5%. What is the present value of the interest tax shield in this case?

Ten years have passed since BBA issued $10 million in perpetual interest-only debt with a 6% annual coupon. Tax rates have remained the same at 30% but interest rates have dropped so BBA’s current cost of debt capital is 4%.

  1. d) What is BBA’s annual interest tax shield now?
  2. e) What is the present value of the interest tax shield now?
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