Doubts

In Class Exercises - Limits of Debt

In Class Exercises - Limits of Debt

by Sofia Lampreia Alves Garcia -
Number of replies: 1

Hi Professor,

I’m confused about the ITS calculation in Exercise 3(c). In the formula:

PV(ITS) = (1/3) × (130 × 0.3) / 1.05

Where does the 130 come from? Is it the interest rate from part (b)? I thought ITS = D × t, so I’m not sure how this fits.

Could you please explain how we get that number?

Thanks,
Sofia


In reply to Sofia Lampreia Alves Garcia

Re: In Class Exercises - Limits of Debt

by Julio Crego -
Dear Sofia,

Yes, it is the interest expense. The ITS is always the corporate tax time the interest expense. However, when debt is constant and perpetual we have:

\(ITS = \tau InterestExpense = \tau (D\times r_D)\)

once we discount:

\(PV(ITS) = \dfrac{\tau (D\times r_D)}{r_D} = \tau D \)