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Problem 18-12 Tax shields Digital Organics (DO) has the opportunity

Problem 18-12 Tax shields

Compute the Present Value of interest tax shields generated by these three debt issues.  Consider corporate taxes only.  The marginal tax rate is Tc =0.40.
a.       A $2,000, one-year loan at 6% interest
b.       A five-year loan of $2,000 at 6% interest.  Assume no principal is repaid until maturity.
c.       A $2,000 perpetuity at 5% interest




Digital Organics (DO) has the opportunity to invest $0.96 million now (t = 0) and expects after-tax returns of $560,000 in t = 1 and $660,000 in t = 2. The project will last for two years only. The appropriate cost of capital is 10% with all-equity financing, the borrowing rate is 6%, and DO will borrow $260,000 against the project. This debt must be repaid in two equal installments. Assume debt tax shields have a net value of $0.35 per dollar of interest paid. Calculate the project’s APV. (Do not round intermediate calculations. Round down your answer to the nearest whole dollar.)



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