- This topic has 2 replies, 2 voices, and was last updated 10 years ago by
.
- Posts
Hi sir
BPP solution, when calculating tax shield, for bank loan, they say:
30 * .25 = 7.530 is the value of the loan, not the actually interest on the loan.
I thought the tax shield is calculated by multiplying the interest on the loan by the tax rate? Also, not sure why they have not discounted this to reflect the PV?Thanks for your help
The tax shield is calculated by discounting the tax saving on the interest by the return on debt (or you can discount at the risk free rate instead – the examiner accepts either even though they give different answers).
If you discount at the return on debt, then it will come to the same answer as what you have written above from the BPP solution. The amount of the loan will be the internet discounted at the return on debt (i.e. the interest rate), and so the tax saving on the interest when discounted at the same rate will be equal to the amount of the loan multiplied by the tax rate.
(This only works for bank loans because the repayment will equal the amount of the loan. With bonds etc this will not usually be the case – the repayment will not equal the current market value – and so then you have to discount the tax savings on the interest.)
- You must be logged in to reply to this topic.