Tax Shields

Lesson:

A tax shield is a method to reduce taxable income through the use of deductions. In many cases, the deduction is due to interest payments from debt.

The formula we use is: TAX SHIELD = TAX RATE X INTEREST EXPENSE

You're an auditor double-checking the math on a firm's tax shield.

Here are the relevant facts:

  • The tax shield is $3,000.00.
  • The tax rate is 0.20.
What is the interest expense?

Answer:

  • The interest expense is $15,000.00.

Explanation:

  1. First, let's remember the formula we need:
    TAX SHIELD = INTEREST EXPENSE × TAX RATE
  2. Next, let's plug in the numbers that we know. The order that we fill in the numbers doesn't matter.
  3. Let's plug in the tax shield.
    $3,000.00 = INTEREST EXPENSE × TAX RATE
  4. Let's plug in the tax rate.
    $3,000.00 = INTEREST EXPENSE × 0.20
  5. Finally, we just have to solve for interest expense.
    $15,000.00 = INTEREST EXPENSE
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