Question

I have 8 million at 9% per annum payable over next five years . The tax rate is 28%. How do I determine the value of the tax shield?

I am doing corporate finance/Finance for decision makers

Answer 1

Tax Shield is calculated for the expenses that are eligible for deduction from the income for Income tax purpose, and one can save tax on the expense thus deducted. Eg. of expenses eligible for deduction are Depreciation and Amortization, Interest expense, expenses for registration and set-up of an entity, etc.

Here, as given, we have to calculate tax shield (Tax saved) from borrowing money and paying interest on it.

As given, principal amount = 8 million

Interest rate = 9% p.a.

Tax rate = 28%

So, we would end up paying 0.72 million p.a. (8 million *9%) which is an expense for us. Due to this expense of 0.72 million, we would save income tax to the tune of 0.2016 million (0.72*28%) as outflow.

If the interest expense would not have been there, we would have to pay 0.2016 million as additional income tax.

So, In short, tax shield is the tax rate multiplied by the expense we are incurring.

Tax Shield = Tax Rate * Expense for the year.

Remember, this formula and you could find tax shield for n number of expenses.