Assume a firm has $450 million in operating profit. The firm’s tax rate is 40%. What is the tax shield of the firm’s $38 million in debt that charges a 10% interest rate?

= $1,520,000

Explanation:

The question is to determine the company's tax shield

A tax shield represents allowable deductions that individuals or organisations are allowed to claim in order to reduce their taxable income. The effect of the tax shield is either to reduce the current year's taxable income or allow for deference of income taxes to a later year.

The tax shield of the firm is as follows

Tax shield = Value of the company's debt x The interest rate x the tax rate

= $38,000,000 x 10% x 40%

= $1,520,000

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