Historically, Meta Platforms (parent company of Facebook) has had more cash than debt. As Problem 21 in Chapter 15 makes clear, by issuing more debt Meta could generate a very large tax shield worth billions. Given Meta’s success, one would be hard pressed to argue that Meta’s management are unaware of this potential benefit of debt. Presumably, management believes issuing debt would entail other costs. What might these costs be?

Data from in problem 21 

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?