Definition
Tax shields reduce a company's tax liability by lowering taxable income. The most important tax shields are interest expense deduction (making debt cheaper) and depreciation (non-cash expense reducing taxes). The value of a tax shield = deductible amount × tax rate. Tax shields directly increase after-tax cash flow and are a key reason companies use debt financing.
functions Formula
Tax Shield Value = Deductible Expense × Tax Rate
lightbulb Example
A company has $10M in interest expense and a 25% tax rate. Tax shield = $10M × 25% = $2.5M. The after-tax cost of $10M interest is only $7.5M because the government effectively subsidizes $2.5M through the tax deduction.
verified_user Key Points
- Reduces taxes through deductible expenses
- Interest tax shield makes debt cheaper
- Depreciation tax shield from non-cash expense
- Value = deductible amount × tax rate