If a company has incurred total interest expense of $6.0 million and the tax rate is 25%, what is the value of the tax shield (tax savings) on the interest?

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Multiple Choice

If a company has incurred total interest expense of $6.0 million and the tax rate is 25%, what is the value of the tax shield (tax savings) on the interest?

Explanation:
Interest expense reduces taxable income, so it creates a tax shield that equals the tax rate times the interest expense. With a 25% tax rate and $6.0 million of interest, the tax shield is 0.25 × 6.0 = $1.5 million. So the tax savings from the interest deduction is $1.5 million. (As a related note, the after-tax cost of debt would be 6.0 × (1 − 0.25) = $4.5 million, but the tax shield itself is $1.5 million.)

Interest expense reduces taxable income, so it creates a tax shield that equals the tax rate times the interest expense. With a 25% tax rate and $6.0 million of interest, the tax shield is 0.25 × 6.0 = $1.5 million. So the tax savings from the interest deduction is $1.5 million. (As a related note, the after-tax cost of debt would be 6.0 × (1 − 0.25) = $4.5 million, but the tax shield itself is $1.5 million.)

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