Question

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 $270 million per year permanently. Assume Facebook's marginal corporate tax rate is 37 % and its borrowing cost is 4.5 %.

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

b. How does your answer change if instead you assume that Facebook's investors pay a 20 % tax rate on income from equity and a 39.6 % tax rate on interest income?

Answer #1

A. Value of Tax Shields = Tax Reduction / Borrowing Cost = $270 Million / 4.5% = $6000 Million or $6 Billion

B. Debt value to provide $250 Million tax shield = Tax Reduction / (corporate tax * Borrowing Cost) = $270 / (37%*4.50%) = $17142.86 Million

Effective Tax Rate = 1 - [(1 - Corporate tax) * (1 - Personal Income Tax)]/(1 - Tax on Interest)]

Effective Tax Rate = 1 - [(1 - 0.37) * (1 - 0.20)]/(1 - 0.396)]

**Effective Tax Rate = 1 - 0.8344 = 16.56%**

**Value of tax Shield = Debt * Tax rate = 17142.86 M *
16.56% = $2838.22 Million**

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