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Braxton Enterprises currently has debt outstanding of $35 million and an interest rate of 8%....

Question:

Braxton Enterprises currently has debt outstanding of {eq}\$35 {/eq} million and an interest rate of {eq}8 \% {/eq}. Braxton plans to reduce its debt by repaying {eq}\$7 {/eq} million in principal at the end of each year for the next five years. If Braxton's marginal corporate tax rate is {eq}40 \% {/eq}, what is the interest tax shield from Braxton's debt in each of the next five years?

Interest Tax Shield:

Interest tax shield refers to the tax benefits arising from the payment of interest. Interest is a charge against profits and an allowable expenditure for calculation of income tax. So, interest expense reduces the profits and the tax henceforth. This reduction in tax because of interest is the interest tax shield.

Answer and Explanation:

Interest tax shield
= Interest amount x Tax Rate
= (Opening balance of loan x Interest rate) x Tax Rate

So, The interest tax shield each year of the company is:

Particulars Year 1 Year 2 Year 3 Year 4 Year 5
Opening Balance of Loan 35,000,000.00 28,000,000.00 21,000,000.00 14,000,000.00 7,000,000.00
Interest (Op. Bal x 8%) 2,800,000.00 2,240,000.00 1,680,000.00 1,120,000.00 560,000.00
Interest tax shield (Interest x 40%) 1,120,000.00 896,000.00 672,000.00 448,000.00 224,000.00
  • The opening balance of loan on which interest is charged is reduced by $7 million each year because of repayment.

Learn more about this topic:

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How to Calculate Interest Expense: Formula & Example

from Financial Accounting: Help and Review

Chapter 5 / Lesson 18
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