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Hello, John
In adjusted present value calculations, the tax shield benefit is normally related to the debt capacity of the investment, not the actual amount of debt finance used. Since this is not given, it is assumed that the increase in debt capacity is equal to the debt finance used.
I didn’t quite understand this assumption. I wonder if you could clarify this to me.
Taking on a new investment will enable the company to be able to raise more debt (i.e. the debt capacity). Strictly we should use the the debt that could be raised when calculating the tax shield and not the actual debt that they raise at the moment (which could be lower). However unless we are told the debt capacity (which is unlikely in the exam) we have no choice but to use the amount of debt actually raised.
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