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Company XYZ is an all-equity firm. It is planning to change its capital structure starting this year and next year by borrowing the amount of

Company XYZ is an all-equity firm. It is planning to change its capital structure starting this year and next year by borrowing the amount of debt indicated below. The interest payments are paid in the following year.

Year 0

Year 1

Debt outstanding

$100 million

$200 million

The current interest rate on debt is 5% and the corporate tax rate is 40%. Both are expected to be constant for two years.

1.Calculate the interest tax shield for each year.

2.Calculate the present value of the interest tax shield for each year, and the total PV(ITS). Assume the interest rate on the debt is the debt cost of capital.

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