Interest tax shield
Principles of Finance glossary · Cost of Capital & Capital Structure
Definition
The tax saving generated by the deductibility of interest expense: annual shield = T · I, where T is the marginal tax rate and I is interest paid. The present value of perpetual shields under the M&M with-tax assumption is T · D, where D is debt outstanding.
Interest tax shield in plain English
When a company borrows money, it pays interest on that loan — and here's the nice part: the government lets it subtract that interest from its profit before calculating the tax it owes. Less taxable profit means a smaller tax bill, so borrowing quietly hands the company a tax discount, and that saved money is the "interest tax shield." Each year the saving equals the tax rate times the interest paid (T · I): if you pay $100 in interest and your tax rate is 30%, you save $30 in taxes. If a company keeps that debt going forever, the total value of all those future savings works out to T · D — the tax rate times the amount of debt owed.
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