BraxtonBraxton 

Enterprises currently has debt outstanding of 

$ 20$20 

million and an interest rate of 

10 %10%. 

BraxtonBraxton 

plans to reduce its debt by repaying 

$ 4$4 

million in principal at the end of each year for the next five years. If 

BraxtonBraxton​'s 

marginal corporate tax rate is 

25 %25%​, 

what is the interest tax shield from 

BraxtonBraxton​'s 

debt in each of the next five​ years?

Question content area bottom

Part 1

The interest tax shield in year one is 

​$enter your response here 

million. ​ (Round to three decimal​ places.)

The interest tax shield is the amount of tax savings a company gets due to the deductibility of interest payments. The formula for the interest tax shield is:

\[
\text{Interest Tax Shield} = \text{Interest Payment} \times \text{Tax Rate}
\]

Let's calculate the interest tax shield for each of the next five years. Here's how we break it down:

### Year 1:
- **Debt Outstanding**: $20 million
- **Interest Rate**: 10% 
- **Interest Payment**: $ 20 \times 0.10 = 2 $ million
- **Tax Rate**: 25%
- **Interest Tax Shield**: $ 2 \times 0.25 = 0.5 $ million

So, the interest tax shield for Year 1 is **$0.500 million**.

### Subsequent Years:
Each year, the principal decreases by $4 million. This affects the interest payments, and thus the interest tax shield.

### Year 2:
- **Debt Outstanding**: $ 20 - 4 = 16 $ million
- **Interest Payment**: $ 16 \times 0.10 = 1.6 $ million
- **Interest Tax Shield**: $ 1.6 \times 0.25 = 0.400 $ million

### Year 3:
- **Debt Outstanding**: $ 16 - 4 = 12 $ million
- **Interest Payment**: $ 12 \times 0.10 = 1.2 $ million
- **Interest Tax Shield**: $ 1.2 \times 0.25 = 0.300 $ million

### Year 4:
- **Debt Outstanding**: $ 12 - 4 = 8 $ million
- **Interest Payment**: $ 8 \times 0.10 = 0.8 $ million
- **Interest Tax Shield**: $ 0.8 \times 0.25 = 0.200 $ million

### Year 5:
- **Debt Outstanding**: $ 8 - 4 = 4 $ million
- **Interest Payment**: $ 4 \times 0.10 = 0.4 $ million
- **Interest Tax Shield**: $ 0.4 \times 0.25 = 0.100 $ million

### Summary of Interest Tax Shields:
1. Year 1: **$0.500 million**
2. Year 2: **$0.400 million**
3. Year 3: **$0.300 million**
4. Year 4: **$0.200 million**
5. Year 5: **$0.100 million**

Would you like more details or have any questions on the process?

Here are 5 questions to extend the topic:
1. How would the interest tax shield change if the tax rate was different?
2. What impact does early repayment of debt have on the total tax shield?
3. How does reducing debt affect a company’s interest coverage ratio?
4. Could there be alternative ways to reduce tax liabilities besides debt?
5. How does the interest tax shield influence a company's weighted average cost of capital (WACC)?

**Tip:** Keep in mind that as debt decreases, the interest payments (and thus the tax shield) decrease too, impacting overall savings.

Braxton Enterprises currently has debt outstanding of $20 million and an interest rate of 10%. Braxton plans to reduce its debt by repaying $4 million in principal at the end of each year for the next five years. If Braxton's marginal corporate tax rate is 25%, what is the interest tax shield from Braxton's debt in each of the next five years?

Learn how to calculate the interest tax shield for Braxton Enterprises as it repays $4 million in debt annually over five years. This problem covers key corporate finance concepts, including debt repayment, interest rate calculations, and tax shields. Suitable for finance students at the undergraduate level.

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