4. Assume corporate tax rate is 30% and no personal taxes. Debt is always risk-free. Risk-free...

4. Assume corporate tax rate is 30% and no personal taxes. Debt is always risk-free. Risk-free rate is 5%. a. Zoom Inc. pays 1 million in interest each year for the next 5 years. What is the present value of Zoom’s interest tax shield? b. Zoom Inc. will have free cash flow 10 million in the next year and its free cash flow will grow at a rate of 4% per year thereafter. Zoom has a deb tequity ratio of 1, an equity cost of capital of 10%, and a debt cost of capital of 5%. What is the present value of Zoom’s interest tax shield? c. Zoom Inc. maintains a permanent debt

Solutions

Expert Solution

PV of Interest Tax Shield = Yearly interest * Tax Rate * PVAF(0.05,5)

PV of Interest Tax Shield = $1000000 * 30% * 4.3294767

PV of Interest Tax Shield = $1298843.00

b. Zoom Inc. will have free cash flow 10 million in the next year and its free cash flow will grow at a rate of 4% per year thereafter. Zoom has a debt equity ratio of 1, an equity cost of capital of 10%, and a debt cost of capital of 5%. What is the present value of Zoom’s interest tax shield?

Weighted Cost of Capital = After tax Cost of Debt * Weight of Debt + Cost of Equity * Weight of Equity

Weighted Cost of Capital = 5% * (1 - Tax) * 0.50 + 10% * 0.50

Weighted Cost of Capital = 3.50% * 0.50 + 10% * 0.50

Weighted Cost of Capital = 6.75%
present value of Zoom’s interest tax shield = Yearly interest * Tax Rate * PVAF(0.05,5)

present value of Zoom’s interest tax shield = 1000000 * 30% * PVAF(0.0675,5)

present value of Zoom’s interest tax shield = 1000000 * 30% * 4.12779

present value of Zoom’s interest tax shield = $1238337.07

Please upvote if satisfied

jeff jeffy answered 1 year ago

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