Aswath Damodaran 331
Stated versus Effective Tax Rates
! You need taxable income for interest to provide a tax savings
! In the Disney case, consider the interest expense at 30 % and 40 %
30 % Debt Ratio 40 % Debt Ratio
EBIT $ 2 , 805 m$ 2 , 805 m
Interest Expense$ 1 , 256 m$ 3 , 349 m
Tax Savings $ 1 , 256 *. 373 = 468 2 , 805 *. 373 = $ 1 , 046
Tax Rate 37. 30 % 1 , 046 / 3 , 349 = 31. 2 %
Pre-tax interest rate 6. 00 % 12. 00 %
After-tax Interest Rate 3. 76 % 8. 25 %
! You can deduct only $ 2 , 805 million of the $ 3 , 349 million of the interest
expense at 40 %. Therefore, only 37. 3 % of $ 2 , 805 million is considered as the
tax savings.
We are being conservative. The interest that is not tax deductible can be carried
forward and will probably earn some tax benefit in future periods.
Given that this is a permanent change in capital structure, however, it seems to be
more conservative to just look at the interest expenses that provide a tax benefit
in the current period.
