a tax shield is an allowable deduction that saves you money on a tax bill they differ between countries based on what's eligible or legal in a jurisdiction but here are some examples of the most common tax shield deductions depreciation expense amortization expense and interest expense the value of these tax shields depends on how high the effective tax rate is and the value of the deductions for the company now let's look at how tax shields are used companies use them in two main areas one is for capital structure optimization and the other is accelerated depreciation methods with capital structure optimization since interest expense is tax deductible however the cost of equity is not tax deductible meaning dividends are not tax deductible it makes debt funding that much cheaper than equity funding in terms of accelerated depreciation methods there's a couple things to point out one is that depreciation is a non-cash expense meaning the company doesn't actually pay the expense to anyone so it makes sense for them to accelerate the depreciation make it as quick as possible meaning make the expense as high as possible in the early years so that they can lower their taxable income and lower their taxes because taxes actually are a cash expense now let's look at some example calculations the tax yield formula is equal to the deduction times the tax rate here's an example a company has a debt balance of 8 million with a 10% coupon or interest rate on that debt and a 35% tax rate so the interest expense on the debt is what the deduction is and what the deduction is is 8 million times 10% equal to 800,000 so the interest tax yield is 800 thousand times 35 percent is 280,000 just in that one single year the net present value of the tax shield benefit would be equal to the tax shield in each of the years of this bonds life dis counted back to the present hopefully this illustrates to you how companies use tax yields to lower their taxable income and reduce their taxes