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Wilde Software Development has a 13% unlevered cost of equity
Wilde Software Development has a 13% unlevered cost of equity. Wilde forecasts the following interest expenses, which are expected to grow at a constant 5% rate after Year 3. Wilde's tax rate is 25%.
Year 1 Year 2 Year 3 Interest expenses$70 $85 $105
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) ]
= [ $105 * 0.25 * 1.05 ] / (0.13 - 0.05)
= $27.5625 / 0.08
= $344.53
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
= ($70 * 0.25) / 1.13 + ($85 * 0.25) / 1.13^2 + ($105 * 0.25) / 1.13^3 + 1 / 1.13^3 * $344.53
= $ 17.5 / 1.13 + $ 21.25 / 1.13^2 + $26.25/ 1.13^3 + $344.53 / 1.13^3
= $17.5 / 1.13 + $21.25/ 1.13^2 + $370.78 / 1.13^3
= $289.10
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