B4 Tax benefits of debt

Question 1

MM proposition I with taxes

Answer 1

The total value of the levered firm exceeds the value of the unlevered firm due to the present value of the tax savings from debt:
V^L = V^U + *PV *(interest tax shield)

Question 2

Valuing the interest tax shield

Answer 2

annual tax savings = t_c * interest payment p.a.

For annuities:
*PV *(interest tax shield) = Annuity * (1/r_f) * (1 - 1/(1+r_f)^T)

With constant debt level D as a perpetuity:
PV (interest tax shield) = t_c * D

Question 3

formula: WACC with taxes

Answer 3

Question 4

figure: WACC with and without taxes

Answer 4

Question 5

Effective tax rate including personal taxes

Answer 5

Question 6

Valuing the interest tax shield with personal taxes and permanent debt

Answer 6

With personal taxes and permanent debt,

V^L = V^U + t* x D * ,* t*: effective tax rate

If t* < t_c, the benefit of leverage is reduced in the presence of personal taxes

Question 7

4 factors that determine the expected marginal tax rate

Answer 7

(1) Progressivity of the statutory tax rate
(2) Federal, state, local and foreign taxes
(3) Uncertainty about the future level of income
(4) Financing and investment related tax shield

Question 8

What is the marginal tax rate today?

Answer 8

The marginal tax rate today is…

… the present value of current plus future taxes to be paid on an additional dollar/euro of current income