# Braxton Enterprises currently has debt outstanding of $55 million and an interest rate of 6%....

## Question:

Braxton Enterprises currently has debt outstanding of $55 million and an interest rate of 6%. Braxton plans to reduce its debt by repaying $11 million in principal at the end of each year for the next five years. If Braxton's marginal corporate tax rate is 40%, what is the interest tax shield from Braxton's debt in each of the next five years?

## Interest tax shield:

Tax shield refers to the benefits arising from paying lower taxes. Interest is an expense charged against profit which reduces the profit and hence the tax payment. This reduction because of interest is known as the interest tax shield.

## Answer and Explanation:

Interest tax shield

= Interest amount x Tax Rate

= Outstanding loan amount x Interest rate x Tax Rate

So the Interest tax shields for all the years are as follows:

Year 1 = 55 x 6% x 40% = $1.32 million

Year 2 = (55 - 11) x 6% x 40% = $1.056 million

Year 3 = (55 - 22) x 6% x 40% = $0.792 million

Year 4 = (55 - 33) x 6% x 40% = $0.528 million

Year 5 = (55 - 44) x 6% x 40% = $0.264 million

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from Financial Accounting: Help and Review

Chapter 5 / Lesson 18