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Hello John,
While I understood the way you calculated the PV of the tax benefit on debt interest in your example 2 Chapter 12 for the 5 years loan, I’ve seen couple of examples where the calculation is quite different and more complex, something as below. I am trying to understand the reason, the question basically talks about a Bank loan, repayable in equal annual instalments over the project’s life, interest payable at 8% per year:
Here is the calculation I’ve seen:
Annual repayment = ($70m/PVA 8% Yr 1 – 4) = ($70m/3·312) = $21,135,266
Year 1 2 3 4
Opening balance 70,000 54,465 37,687 19,567
Interest at 8% 5,600 4,357 3,015 1,565
Repayment (21,135) (21,135) (21,135) (21,135)
Closing balance 54,465 37,687 19,567 (3)Year 1 2 3 4
Interest cost 5,600 4,357 3,015 1,565
Tax relief at 30% 1,680 1,307 905 470
Discount factor 8% 0·926 0·857 0·794 0·735
Present value 1,556 1,120 719 345
Net present value 3,740Many thanks,
RoxanaUsually the loan interest (and therefore the tax benefit of the interest) is a fixed amount each year.
However, if the loan is repaid in equal annual instalments (that include the interest) then the equal payment each year is the amount of the loan divided by the annuity factor. Given that this repayment is partly interest and partly loan repayment, the amount of interest each year is changing (it is decreasing) and therefore the amount of the tax saving is changing also.
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