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Determining the present value of the tax shield

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Duffy was just hired as CEO of Dog Food Inc. (DFI), which has no debt on its balance sheet. He also forecasts that the firm is expected to pay $200 million/year in taxes and is expected to have a constant 20% tax rate.

a) Assuming no personal taxes, if Duffy were to issue $75 million in perpetual debt at 7%, but this would generate an expected present value of - $1 million in financial distress costs, what is the total present value of the tax shield and financial distress costs?

b) Assuming no bankruptcy costs, but personal taxes of 30% on income from equity and 50% on income from interest, if Duffy were to issue $100 million in perpetual debt at 8%, what is the present value of the tax shield?

Reference no: EM132730291

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