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Summit Builders has a market​ debt-equity ratio of 0.65 and a corporate tax rate of 40 %​, and it pays 7 % interest on its debt.
The interest tax shield from its debt lowers​ Summit's WACC by what​ amount?

Respuesta :

Answer:

1.103%

Explanation:

Data provided in the question:

Market​ debt-equity ratio = 0.65

Corporate tax rate = 40%

Interest on paid its debt = 7%

Now,

Debt Ă· Equity = 0.65

or

Debt = 0.65 Ă— Equity

Weight of Debt = Debt Ă· (Debt + Equity)

or

= ( 0.65 Ă— Equity ) Ă· ( 0.65 Ă— Equity + Equity )

= 0.65 Ă· 1.65

= 0.3939

also,

Tax shield = Corporate tax rate Ă— Interest paid on its debt

= 0.40 Ă— 0.07

= 0.028

= 2.8%

Therefore,

The interest tax shield from its debt lowers​ Summit's WACC by

= Weight of Debt  × Tax shield

= 0.3939 Ă— 2.8%

= 1.103%

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