×QvantCase
← All techniques

Finance · level 2

Interest tax shield

Interest is deductible, so every dollar of interest saves τ dollars of tax. With permanent debt the present value collapses to τ × D — the cleanest result in capital structure.

Theory: Corporate Finance 

Worked example: A firm carries $720M of debt at 6% and pays 30% tax. How much tax does the interest save each year?

interest$43.2M
tax rate30%
annual shield$12.96M

Step by step

  1. 1

    Interest

    $720M × 6% = $43.2M

  2. 2

    Times the tax rate

    $43.2M × 30% = $12.96M

  3. 3

    Why it is value

    The shield is a cash flow to investors that would otherwise go to the tax authority. Discounted, it is the tax advantage of debt.

A firm carries $720M of debt at 6% and pays 30% tax. How much tax does the interest save each year? = 12,960,000

The theory behind it

Intuition

Finance is time and risk applied to cash: move every cash flow to the same date at a rate that reflects its risk, then compare.

Common pitfalls

  • ×Discounting a nominal flow at a real rate (or vice versa).
  • ×Mixing enterprise-value and equity-value numbers in the same ratio.

In the interview

Valuation, WACC, LBO and accretion rounds — where a wrong bridge is a wrong answer.