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Wilde Software Development has a 12% unlevered cost of equity
Wilde Software Development has a 12% unlevered cost of equity. Wilde forecasts the following interest expenses, which are expected to grow at a constant 2% rate after Year 3. Wilde's tax rate is 25%.
Year 1 - $75
Year 2 $100
Year 3 $135
- A. What is the horizon value of the interest tax shield? Do not round intermediate calculations. Round your answer to the nearest cent
$
- What is the total value of the interest tax shield at Year 0? Do not round intermediate calculations. Round your answer to the nearest cent.
$
Expert Solution
a. Computation of Horizon Value of the Interest Tax Shield:
= [ Interest expense in year 3 * Tax Rate * (1 + Growth Rate) ] / (Unlevered Cost of Equity - Growth Rate) ]
= [ $135 * 0.25 * 1.02 ] / (0.12 - 0.02)
= $34.425 / 0.10
= $344.25
b. Computation of Total Value of Interest Tax Shield:
= (Interest expense in year 1 * Tax rate) / (1 + Unlevered cost of equity) + (Interest expense in year 2 * Tax rate) / (1 + Unlevered cost of equity)^2 + (Interest expense in year 3 * Tax rate) / (1 + Unlevered cost of equity)^3 + 1 / (1 + Unlevered cost of equity)^3 * Horizon value
= ($75 * 0.25) / 1.12 + ($100 * 0.25) / 1.12^2 + ($135 * 0.25) / 1.12^3 + 1 / 1.12^3 * $344.25
= $ 18.75 / 1.12 + $ 25 / 1.12^2 + $33.75/ 1.12^3 + $344.25 / 1.12^3
= $18.75 / 1.12 + $25/ 1.12^2 + $378 / 1.12^3
= $305.72
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