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For the discount rate use for tax shield on interest payment, subsidiary loan,
Can we just use risk free rate to discount all tax shield?
because i refer to BPP text book, it mentioned must use cost of debt to discount the tax relief on interest cost.
so i am a bit confused what rate/which rate is better.
and how to calculate the tax shield on the increased debt capacity? can you provide example? i refer to the BPP text book but still can’t understand. and why increased debt capacity will have tax shield effect?
You can use either the cost of debt or the risk free rate – the examiner always accepts either, because there are arguments for both of them.
There is an example in my lecture notes (and lectures) on increased debt capacity. If doing the project increases the debt capacity then we treat the tax shield on all of it as a benefit even if you won’t take all the extra debt immediately.
Hi Sir, i can’t find the related increased debt capacity in your lecture note and lecture.
may i know is in which page and which lecture?and regarding the subsidiary loan, the annual subsidiary benefit formula = interest save on subsidiary loan x (1-tax rate), am i correct?
because i refer to BPP text book, , there is no x(1-tax rate), but i refer to June 2014 Q2A, the annual subsidiary benefit got x (1-tax rate)
You are quite right – I was sure I mentioned debt capacity but when I check I didn’t 🙂
However, it doesn’t make the workings really any different – you just calculate the tax benefit on the debt capacity rather than on the debt actually raised at the time.With regard to the tax, what you have written is correct. Probably in the BPP book they have calculated the tax on the debt raised differently ion the first place so the net effect will be the same (but I cannot check because I do not have the BPP Study Text).
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