When B&M compute the PV of the tax shield, why are they just dividing by i instead of (1+i)?  Unless they are assuming this goes on for perpetuity (they would make 1000 every year, no interest rate risk or anything), this doesn't make sense.

Also, I know that the dividends are not taxed twice, so that part makes sense.  But why are B&M combining the income to bondholders (=debt) and stockholders (=equity)?  I thought the financial manager's goal was to maximize the wealth of the STOCKholders, and thus the business grows.

Later on the page, where it talks about the present values: Why is the interest rate charged equal to the return on debt?  I've understood this course so far up to this point, but this chapter is really stumping me.

cgnech,

I'll give your questions a shot, although I'm not 100% clear on all of this myself.

B&M actually are assuming that the $1000 debt goes on in perpetuity, resulting in a $28 tax shield every year. See the second sentence of the last paragraph on p. 469: "Suppose that the debt of L is fixed and permanent."

In Table 18.1, B&M are just comparing the total amount of income available to be paid out by the company. Both the bondholders and the stockholders are essentially "investors" in the company, in that both are entering into a financial arrangement in which they hope to get a return on an investment. See the second sentence of the third full paragraph on page 484: "If we hold business risk constant, any increase in firm value is shared among bondholders and stockholders. The value of any investment opportunity to the firm's stockholders is reduced because project benefits must be shared with bondholders." So, clearly, financial managers sometimes do make decisions that enhance the wealth of bondholders at the expense of stockholders.

I'm pretty sure that "return on debt" is defined as the interest rate charged to the company on its debt. The two terms are synonyms, like "pretax" and "before tax."