quiz 9

q.9 In 2018, Mastercard Incorporated had a market capitalization of $200 billion, debt of $6.5 billion, cash of $8.2 billion, and EBIT of nearly $7

billion. If Mastercard were to increase its debt by $1 billion and use the cash for a share repurchase, which market imperfections would be most relevant for understanding the consequence for Mastercard's value? Why?

(Choose the best answer below.)

A.Mastercard's debt is a tiny fraction of its total value. Indeed, Mastercard has more cash than debt, so its net debt is negative. Mastercard is also very profitable; at an interest rate of 6%, interest on Mastercard's debt is only $390million per year, which is around 5.57%of its EBIT.

B. The risk that Mastercard will default on its debt is extremely small. This risk will remain extremely small even if Mastercard borrows an additional $1 billion. Thus, adding debt will not really change the likelihood of financial distress for Mastercard (which is nearly zero), and thus will also not lead to agency conflicts.

C. The most important financial friction for such a debt increase is the tax savings Mastercard would receive from the interest tax shield. A secondary issue may be the signaling impact of the transaction-borrowing to do a share repurchase is usually interpreted as a positive signal that management may view the shares to be underpriced.

D. All of the above.