You are a first-year analyst at Bayou Capital. You have been tasked with calculating the present value of all interest tax shields that will be generated in the firm’s latest leveraged buyout. The LBO target will have the following amounts of debt outstanding every year:
Year 0 - 5000
Year 1 - 4600
Year 2 - 4300
Year 3 - 4000
Year 4 - 3500
Year 5 - 3000
After year five, the amount of debt outstanding will grow at a constant rate of 2% per year. The interest rate on the firm’s debt is 10% during the first five years and 7% from year six onwards. Interest has to be paid at the end of each year based on the amount of debt outstanding as of the end of the previous year. The risk-free rate is 3%. The expected return on the overall stock market is 8%. The target’s equity beta is 1.8. The corporate tax rate is 35%. Year zero ended yesterday.
Please calculate the present value of all interest tax shields generated in the LBO. Someone else is handling the calculation of unlevered firm value, flotation fees etc. so you do not need to do that.