Facebook, Inc. had no debt on its balance sheet in 2014, but paid $2 billion in taxes. Suppose Facebook were to issue sufficient debt to reduce its taxes by $250 million per year permanently.

Assume Facebook’s marginal corporate tax rate is 35% and its borrowing cost is 5%.

a. How much debt would Facebook need to issue?

b. If Facebook’s investors do not pay personal taxes (because they hold their Facebook stock in taxfree retirement accounts), how much value would be created (what is the value of the tax shield)?

c. Suppose Facebook issues the amount of debt in (a), but suppose Facebook’s investors pay a 20% tax rate on income from equity and a 39.6% tax rate on interest income. What is the value of the tax shield from the new debt in this case?

AppendixLO1