Question

Google Corporation has no debt on its balance sheet in 2008 but paid $1.6 billion in taxes. Also, Google's marginal tax rate is 35% and Google's borrowing cost is 7%. Assume that investors hold Google stock in retirement accounts that are free from personal taxes. If Google were to issue sufficient debt to reduce its taxes by $1 billion per year permanently, then the amount that Google needs to borrow is closest to: Select one:

a. $22.00 billion

b. $24.50 billion

c. $40.75 billion

d. $14.25 billion

Answer 1

Sol:

Marginal tax rate = 35%

Borrowing cost = 7%

If Google were to issue sufficient debt to reduce its taxes by $1 billion per year permanently, then the amount that Google needs to borrow is closest to:

The amount of interest expense it need to book, for saving 1 billion taxes will be = $1 billion / 35% tax rate = approximate $2.86 billion.

Now to book interest expense of 2.86 billion, the amount it need to borrow will be = $2.86 / 7% = approximate $40.86 billion.

Therefore the amount Google needs to borrow to reduce its taxes permanently by $1 million per year will be closest to $40.75 billion.

Ans is c. $40.75 billion