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ACCA Strategic Professional · Advanced Financial Management · Impact of financing on investment decisions and adjusted present values

Zeta Co will borrow $4 million of debt at 6% annual interest for a project, with interest paid at each year end for 4 years and the principal repaid at the end of year 4. Corporation tax is 25%, payable in the year the interest is incurred. The tax shield is discounted at the pre-tax cost of debt of 6%. The 4-year annuity factor at 6% is 3.465. What is the present value of the interest tax shield?

The present value of the tax shield is $207,900. Annual interest of $240,000 produces a tax saving of $60,000 at 25%, and discounting this for four years at 6% using the annuity factor of 3.465 gives $207,900.

  1. A$207,900Correct
  2. B$831,600
  3. C$240,000
  4. D$1,000,000

Explanation

Annual interest = 4,000,000 x 6% = 240,000. Annual tax shield = 240,000 x 25% = 60,000. PV = 60,000 x 3.465 = 207,900. Option $831,600 uses 240,000 x 3.465 with no tax rate (missed tax), and $240,000 is the interest itself.

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