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The Interest Tax Shield

Why is it important to calculate the value of the interest tax shield if a firm adjusts its debt annually to a target level?

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//This paper is about interest tax shield and its importance in adjusting the annual debt to a targeted level. A tax shield is the reduction in income taxes, which is the result of taking an allowable deduction from taxable income.//

Tax shield is a reduction in tax, which is the result of a tax-deductible expense such as interest on a debt. Therefore, making debt creates a tax shield. It is a way to save cash flows therefore, it is important in business valuation. Corporations have to pay taxes on the income or profit earned after the deductions on the interest payments. Therefore, these deductions reduce the overall taxable income. This is an incentive given to use debt by the tax code.

When a firm uses debt, the interest tax shield provides a corporate tax benefit each year. To ...

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