In$2018,$ Mastercard Incorporated had a market capitalization of

$ $200$$$200$

$$billion$,$ debt of

$ $6\mathrm{.}5$$$6\mathrm{.}5$

$$billion$,$ cash of

$ $8\mathrm{.}2$$$8\mathrm{.}2$

$$billion$,$ and EBIT of nearly

$ $7$$$7$

billion. If Mastercard were to increase its debt by

$ $1$$$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?

Question content area bottom

Part $1$

$($Choose the best answer$$ below.$)$

A$.$

$$Mastercard$\text{'}$s debt is a tiny fraction of its total value.$$ Indeed, Mastercard has more cash than$$ debt, so its net debt is negative. Mastercard is also very$$ profitable; at an interest rate of

$6\%6\%,$

interest on$$ Mastercard's debt is only

$ $390$$$390$million

per$$ year, which is around

$5\mathrm{.}57\%5\mathrm{.}57\%$

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.