The definition of interest tax shield and value of tax shield.

Question

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Answer 1

Question

Chapter 17, Problem 1Q

a)

Summary Introduction

To determine: The definition of interest tax shield and value of tax shield.

a)

Expert Solution

Explanation of Solution

The interest tax shield is the amount of cash flow shielded from taxes due to interest tax deductibility. It's the same as rd(D)(T). The tax shield's benefit is the present value of future tax income from interest payment deductibility. The tax shield's value depends on the rate (rTS) used to offset future annual tax shields. In the tax model of the MM, rTS=rd

Because MM assume zero growth, the value of the tax shield is T(D). If growth is constant, then the value of the tax shield is rdTD(1+gL)(rTS−gL). Where rd is the interest rate on the debt and rTS is the discount rate for the tax shield.

b)

Summary Introduction

To determine: The definition of adjusted present value (APV) model.

b)

Expert Solution

Explanation of Solution

The adjusted present-value model discounts expected free cash flows at rTS's unlevered cost of equity and discounts interest tax shields.

c)

Summary Introduction

To determine: The definition of compressed adjusted present value (CAPV) model.

c)

Expert Solution

Explanation of Solution

The condensed modified present-value method discounts expected free cash flows at the unlevered equity cost and also discounted interest tax shields at the unlevered equity cost to determine the value of transactions. It is called the compact APV because there is a discount on the FCF and tax shields at the same price.

d)

Summary Introduction

To determine: The definition of free cash flow to equity model.

d)

Expert Solution

Explanation of Solution

This then reduces the FCFEs to hit the price of capital in operations at the leveraged cost of equity. You apply non-operating capital to the value and you get the equity value. You then apply the price of the loan to the value of the transactions. First, the free cash flow for the equity model, or the residual dividend model, measures FCFE, the free cash flow owned by shareholders. FCFE is less interest in cost-free cash flow plus interest tax shield.

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Students have asked these similar questions

The prodave paint company earned a net profit margin of 20% on revenues of $20m this year. Fixed Capital Investment was $2 m and depreciation was $3 m. Working capital Investment equals 7.5% of the Sales level in that year. Net income, fixed Capital Investment, depreciation, interest expenses and sales are expected to grow at 10% per year for the next 5 years. After 5 years, the growth in sales , net income, depreciation and interest expenses will decline to a stable 5% per year and fixed Capital Investment and depreciation will offset each other. The tax rate is 40% and the prodave has 1 m shares of common stock outstanding and long term debt paying 12.5% interest trading at it's par value of $32 m. The WACC is 17% during the high growth stage and 15% during the stable growth stage. Required: a) Calculate FCFE b) Determine FCFF c) Estimate the value of Equity d) Calculate the value of the Firm

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Answer 2

Question

Chapter 17, Problem 1Q

a)

Summary Introduction

To determine: The definition of interest tax shield and value of tax shield.

a)

Expert Solution

Explanation of Solution

The interest tax shield is the amount of cash flow shielded from taxes due to interest tax deductibility. It's the same as rd(D)(T). The tax shield's benefit is the present value of future tax income from interest payment deductibility. The tax shield's value depends on the rate (rTS) used to offset future annual tax shields. In the tax model of the MM, rTS=rd

Because MM assume zero growth, the value of the tax shield is T(D). If growth is constant, then the value of the tax shield is rdTD(1+gL)(rTS−gL). Where rd is the interest rate on the debt and rTS is the discount rate for the tax shield.

b)

Summary Introduction

To determine: The definition of adjusted present value (APV) model.

b)

Expert Solution

Explanation of Solution

The adjusted present-value model discounts expected free cash flows at rTS's unlevered cost of equity and discounts interest tax shields.

c)

Summary Introduction

To determine: The definition of compressed adjusted present value (CAPV) model.

c)

Expert Solution

Explanation of Solution

The condensed modified present-value method discounts expected free cash flows at the unlevered equity cost and also discounted interest tax shields at the unlevered equity cost to determine the value of transactions. It is called the compact APV because there is a discount on the FCF and tax shields at the same price.

d)

Summary Introduction

To determine: The definition of free cash flow to equity model.

d)

Expert Solution

Explanation of Solution

This then reduces the FCFEs to hit the price of capital in operations at the leveraged cost of equity. You apply non-operating capital to the value and you get the equity value. You then apply the price of the loan to the value of the transactions. First, the free cash flow for the equity model, or the residual dividend model, measures FCFE, the free cash flow owned by shareholders. FCFE is less interest in cost-free cash flow plus interest tax shield.

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Answer 3

Question

Chapter 17, Problem 1Q

a)

Summary Introduction

To determine: The definition of interest tax shield and value of tax shield.

a)

Expert Solution

Explanation of Solution

The interest tax shield is the amount of cash flow shielded from taxes due to interest tax deductibility. It's the same as rd(D)(T). The tax shield's benefit is the present value of future tax income from interest payment deductibility. The tax shield's value depends on the rate (rTS) used to offset future annual tax shields. In the tax model of the MM, rTS=rd

Because MM assume zero growth, the value of the tax shield is T(D). If growth is constant, then the value of the tax shield is rdTD(1+gL)(rTS−gL). Where rd is the interest rate on the debt and rTS is the discount rate for the tax shield.

b)

Summary Introduction

To determine: The definition of adjusted present value (APV) model.

b)

Expert Solution

Explanation of Solution

The adjusted present-value model discounts expected free cash flows at rTS's unlevered cost of equity and discounts interest tax shields.

c)

Summary Introduction

To determine: The definition of compressed adjusted present value (CAPV) model.

c)

Expert Solution

Explanation of Solution

The condensed modified present-value method discounts expected free cash flows at the unlevered equity cost and also discounted interest tax shields at the unlevered equity cost to determine the value of transactions. It is called the compact APV because there is a discount on the FCF and tax shields at the same price.

d)

Summary Introduction

To determine: The definition of free cash flow to equity model.

d)

Expert Solution

Explanation of Solution

This then reduces the FCFEs to hit the price of capital in operations at the leveraged cost of equity. You apply non-operating capital to the value and you get the equity value. You then apply the price of the loan to the value of the transactions. First, the free cash flow for the equity model, or the residual dividend model, measures FCFE, the free cash flow owned by shareholders. FCFE is less interest in cost-free cash flow plus interest tax shield.

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Answer 4

Question

Chapter 17, Problem 1Q

a)

Summary Introduction

To determine: The definition of interest tax shield and value of tax shield.

a)

Expert Solution

Explanation of Solution

The interest tax shield is the amount of cash flow shielded from taxes due to interest tax deductibility. It's the same as rd(D)(T). The tax shield's benefit is the present value of future tax income from interest payment deductibility. The tax shield's value depends on the rate (rTS) used to offset future annual tax shields. In the tax model of the MM, rTS=rd

Because MM assume zero growth, the value of the tax shield is T(D). If growth is constant, then the value of the tax shield is rdTD(1+gL)(rTS−gL). Where rd is the interest rate on the debt and rTS is the discount rate for the tax shield.

b)

Summary Introduction

To determine: The definition of adjusted present value (APV) model.

b)

Expert Solution

Explanation of Solution

The adjusted present-value model discounts expected free cash flows at rTS's unlevered cost of equity and discounts interest tax shields.

c)

Summary Introduction

To determine: The definition of compressed adjusted present value (CAPV) model.

c)

Expert Solution

Explanation of Solution

The condensed modified present-value method discounts expected free cash flows at the unlevered equity cost and also discounted interest tax shields at the unlevered equity cost to determine the value of transactions. It is called the compact APV because there is a discount on the FCF and tax shields at the same price.

d)

Summary Introduction

To determine: The definition of free cash flow to equity model.

d)

Expert Solution

Explanation of Solution

This then reduces the FCFEs to hit the price of capital in operations at the leveraged cost of equity. You apply non-operating capital to the value and you get the equity value. You then apply the price of the loan to the value of the transactions. First, the free cash flow for the equity model, or the residual dividend model, measures FCFE, the free cash flow owned by shareholders. FCFE is less interest in cost-free cash flow plus interest tax shield.

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Answer 5

Chapter 17, Problem 1Q

a)

Summary Introduction

To determine: The definition of interest tax shield and value of tax shield.

a)

Expert Solution

Explanation of Solution

The interest tax shield is the amount of cash flow shielded from taxes due to interest tax deductibility. It's the same as rd(D)(T). The tax shield's benefit is the present value of future tax income from interest payment deductibility. The tax shield's value depends on the rate (rTS) used to offset future annual tax shields. In the tax model of the MM, rTS=rd

Because MM assume zero growth, the value of the tax shield is T(D). If growth is constant, then the value of the tax shield is rdTD(1+gL)(rTS−gL). Where rd is the interest rate on the debt and rTS is the discount rate for the tax shield.

b)

Summary Introduction

To determine: The definition of adjusted present value (APV) model.

b)

Expert Solution

Explanation of Solution

The adjusted present-value model discounts expected free cash flows at rTS's unlevered cost of equity and discounts interest tax shields.

c)

Summary Introduction

To determine: The definition of compressed adjusted present value (CAPV) model.

c)

Expert Solution

Explanation of Solution

The condensed modified present-value method discounts expected free cash flows at the unlevered equity cost and also discounted interest tax shields at the unlevered equity cost to determine the value of transactions. It is called the compact APV because there is a discount on the FCF and tax shields at the same price.

d)

Summary Introduction

To determine: The definition of free cash flow to equity model.

d)

Expert Solution

Explanation of Solution

This then reduces the FCFEs to hit the price of capital in operations at the leveraged cost of equity. You apply non-operating capital to the value and you get the equity value. You then apply the price of the loan to the value of the transactions. First, the free cash flow for the equity model, or the residual dividend model, measures FCFE, the free cash flow owned by shareholders. FCFE is less interest in cost-free cash flow plus interest tax shield.

Answer 6

Chapter 17, Problem 1Q

a)

Summary Introduction

To determine: The definition of interest tax shield and value of tax shield.

a)

Expert Solution

Explanation of Solution

The interest tax shield is the amount of cash flow shielded from taxes due to interest tax deductibility. It's the same as rd(D)(T). The tax shield's benefit is the present value of future tax income from interest payment deductibility. The tax shield's value depends on the rate (rTS) used to offset future annual tax shields. In the tax model of the MM, rTS=rd

Because MM assume zero growth, the value of the tax shield is T(D). If growth is constant, then the value of the tax shield is rdTD(1+gL)(rTS−gL). Where rd is the interest rate on the debt and rTS is the discount rate for the tax shield.

Answer 7

Chapter 17, Problem 1Q

a)

Summary Introduction

To determine: The definition of interest tax shield and value of tax shield.

Answer 8

a)

Expert Solution

Explanation of Solution

The interest tax shield is the amount of cash flow shielded from taxes due to interest tax deductibility. It's the same as rd(D)(T). The tax shield's benefit is the present value of future tax income from interest payment deductibility. The tax shield's value depends on the rate (rTS) used to offset future annual tax shields. In the tax model of the MM, rTS=rd

Because MM assume zero growth, the value of the tax shield is T(D). If growth is constant, then the value of the tax shield is rdTD(1+gL)(rTS−gL). Where rd is the interest rate on the debt and rTS is the discount rate for the tax shield.

Answer 9

a)

Expert Solution

Answer 10

a)

Expert Solution

Answer 11

Expert Solution

Answer 12

b)

Summary Introduction

To determine: The definition of adjusted present value (APV) model.

b)

Expert Solution

Explanation of Solution

The adjusted present-value model discounts expected free cash flows at rTS's unlevered cost of equity and discounts interest tax shields.

Answer 13

b)

Summary Introduction

To determine: The definition of adjusted present value (APV) model.

Answer 14

b)

Expert Solution

Explanation of Solution

The adjusted present-value model discounts expected free cash flows at rTS's unlevered cost of equity and discounts interest tax shields.

Answer 15

b)

Expert Solution

Answer 16

b)

Expert Solution

Answer 17

Expert Solution

Answer 18

c)

Summary Introduction

To determine: The definition of compressed adjusted present value (CAPV) model.

c)

Expert Solution

Explanation of Solution

The condensed modified present-value method discounts expected free cash flows at the unlevered equity cost and also discounted interest tax shields at the unlevered equity cost to determine the value of transactions. It is called the compact APV because there is a discount on the FCF and tax shields at the same price.

Answer 19

c)

Summary Introduction

To determine: The definition of compressed adjusted present value (CAPV) model.

Answer 20

c)

Expert Solution

Explanation of Solution

The condensed modified present-value method discounts expected free cash flows at the unlevered equity cost and also discounted interest tax shields at the unlevered equity cost to determine the value of transactions. It is called the compact APV because there is a discount on the FCF and tax shields at the same price.

Answer 21

c)

Expert Solution

Answer 22

c)

Expert Solution

Answer 23

Expert Solution

Answer 24

d)

Summary Introduction

To determine: The definition of free cash flow to equity model.

d)

Expert Solution

Explanation of Solution

This then reduces the FCFEs to hit the price of capital in operations at the leveraged cost of equity. You apply non-operating capital to the value and you get the equity value. You then apply the price of the loan to the value of the transactions. First, the free cash flow for the equity model, or the residual dividend model, measures FCFE, the free cash flow owned by shareholders. FCFE is less interest in cost-free cash flow plus interest tax shield.

Answer 25

d)

Summary Introduction

To determine: The definition of free cash flow to equity model.

Answer 26

d)

Expert Solution

Explanation of Solution

This then reduces the FCFEs to hit the price of capital in operations at the leveraged cost of equity. You apply non-operating capital to the value and you get the equity value. You then apply the price of the loan to the value of the transactions. First, the free cash flow for the equity model, or the residual dividend model, measures FCFE, the free cash flow owned by shareholders. FCFE is less interest in cost-free cash flow plus interest tax shield.