Session 14: Capital Structure and the effect of Corporate Taxes

Question 0

The interest tax shield with permanent debt

Answer 0

firm borrows debt D, keeps the level of debt permanently and debt is riskless with rf:
PV (interest TS)=TcxD (valued as a perpetuity)

Question 1

MM I with Taxes

Answer 1

Vl=Vu+PV (Interest Tax Shield)

Question 2

WACC with taxes

Answer 2

rWACC=(E/D+E)xrE+(D/D+E)rDx(1-Tc)

Question 3

Interest TS with a target D/E ratio

Answer 3

• Compute the pre-tax WACC to find Vu
• Compute the WACC (with taxes) to find Vl
• PV of the interest TS=Vl-Vu