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Calculate the present value of interest tax shield

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Consider a firm that is currently all-equity financed. The firm produces a perpetual EBIT of $90m per annum and has an all-equity cost of capital (required return on equity) of 8 per cent. The corporate tax rate is 30 per cent, and the interest rate on debt is 2.5 per cent. The company is to be acquired under a LBO, under which an initial level of debt of $500m will be taken on, with repayment of $100m per year and interest on the principal at the end of each of years 1, 2, and 3. A level of debt of $200m will then be maintained in perpetuity.

a. Calculate the present value of interest tax shield, you may assume that you can discount any debt-related cash flows at the cost of debt.

b. Calculate the value of the firm before LBO

c. Calculate the value of the firm following LBO using the APV method

Reference no: EM132700797

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