As some of you already know we are fairly new here, and are interested in analysing companies, both from an investment and an interest point of view. The subject that's currently in my mind is using interest as a tax shield.
Now I understand all the maths, but what I don't really understand, is why it is argued as being potentially advantageous, particularly from a cash flow perspective. As usual I have been googling and youtubing, and as usual I seem to find copious amounts of HOW, but not so much of the WHY.
This is one such link:
https://www.youtube.com/watch?v=gxKcxR5p6EA&t=60s
(Note I deliberately set the start time 1 minute in since that's where the figures start to be mentioned.)
Anyway for anyone who does not wish to look at the clip, in summary the youtuber, basically outlines the difference in cash position between the levered and the unlevered firms.
=================Unlevered=================Levered
EBIT 1000 1000
Interest 0 80
--------------------------------------------------
Taxable income 1000 920
Taxes (at 30%) 300 276
--------------------------------------------------
Net income 700 644
Cash flow from assets 700 724
Interest tax shield = 24
Now whilst I understand that the levered firm pays less tax than the unlevered one, what I don't understand is why the levered firm can add the 80 pounds/dollars/etc. of interest back to it's net income, as a cash inflow, since surely this 80 must be handed over to the lender, presumably in cash?
Can anyone explain what is really meant when we say that the interest on the debt creates a more advantageous position regarding cash flow?
many thanks
Matt (and Mel)