Question

XYZ has Sale s= 4,000, COGS = 2,000, Depreciation = 400, Interest = 600.

The tax rates are:10% for taxable income up to 500, 15% for the next 500, and 20% for any taxable income above 1,000

1. What is XYZ’s Interest Tax Shield (ITS)?

A. 90

B.   120

C. 85

D. none of the above

2. What would be the ITS if depreciation is increased to 1,000?

A. 90

B.   120

C. 85

D. none of the above

Answer 1

Formula for:-

Interest Tax Shield = (Annual Interest Rate)*(Tax Rate)

1). First, we will calculate the Taxable Income-

Particular	Amount (in $)
Sales	4000
Less: COGS	(2000)
Gross Profit	2000
Less: Depreciation	(400)
EBIT	1600
Less: Interest	(600)
Taxable Income	1000

As the Taxable Income is $ 1000, the Tax rate will be 15%. (Note- Tax rate of 20% is applicable on Taxable Income more than $ 1000 but since it is $ 1000, 15% tax rate will be applicable.)

Interest Tax Shield = $600*15%

= $90

Hence, Option A. $90

b). Now depreciation is increased to $1000

First, we will calculate the Taxable Income-

Particular	Amount (in $)
Sales	4000
Less: COGS	(2000)
Gross Profit	2000
Less: Depreciation	(1000)
EBIT	1000
Less: Interest	(600)
Taxable Income	400

Tax Slab rate:- 10% for Taxable Income upto $ 500. Thus Tax rate will be 10%

Interest Tax Shield = $600*10%

= $60

Hence, Option D. None of these

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