Ruiz Corporation is an unlevered Timber company with assets of $10.35 million. Ruiz reports earnings before interest and tax of $1.50 million. In order to save on taxes, the CFO has suggested that the firm issue debt and use the proceeds to retire shares of stock. If conducted, the capital structure change would result in $1.50 million of new debt with an annual interest expense of 10 percent.
a. How much will Ruiz save in taxes, per year, as a result of the decision to issue debt? Use a corporate tax rate of 40 percent.
Answer:$ _____ million
Place your answer in millions with at least two decimal places, that is, if your answer is three quarters of a million dollars you should answer 0.75.
b. Suppose instead that the debt is permanent, meaning that the same amount of debt will stay on the books year after year forever. Under this scenario determine the how much in value the permanent debt tax shields provide?
Answer:$ ________million
Place your answer in millions with at least two decimal places, that is, if your answer is three quarters of a million dollars you should answer 0.75.