Question

Question content area top Part 1 Info Systems Technology (IST) manufactures microprocessor chips for use in appliances and other applications. IST has no debt and 200200 million shares outstanding. The correct price for these shares is either $ 12.00$12.00 or $ 9.00$9.00 per share. Investors view both possibilities as equally likely, so the shares currently trade for $ 10.50$10.50. IST must raise $ 350$350 million to build a new production facility. Because the firm would suffer a large loss of both customers and engineering talent in the event of financial distress, managers believe that if IST borrows the $ 350$350 million, the present value of financial distress costs will exceed any tax benefits by $ 10$10 million. At the same time, because investors believe that managers know the correct share price, IST faces a lemons problem if it attempts to raise the $ 350$350 million by issuing equity. a. Suppose that if IST issues equity, the share price will remain $ 10.50$10.50. To maximize the long-term share price of the firm once its true value is known, would managers choose to issue equity or borrow the $ 350$350 million if i. They know the correct value of the shares is $ 9.00$9.00?

          Question content area top
Part 1
Info Systems Technology (IST) manufactures microprocessor chips for use in appliances and other applications. IST has no debt and
200200
million shares outstanding. The correct price for these shares is either
$ 12.00$12.00
or
$ 9.00$9.00
per share. Investors view both possibilities as equally likely, so the shares currently trade for
$ 10.50$10.50.
IST must raise
$ 350$350
million to build a new production facility. Because the firm would suffer a large loss of both customers and engineering talent in the event of financial distress, managers believe that if IST borrows the
$ 350$350
million, the present value of financial distress costs will exceed any tax benefits by
$ 10$10
million. At the same time, because investors believe that managers know the correct share price, IST faces a lemons problem if it attempts to raise the
$ 350$350
million by issuing equity.
a. Suppose that if IST issues equity, the share price will remain
$ 10.50$10.50.
To maximize the long-term share price of the firm once its true value is known, would managers choose to issue equity or borrow the
$ 350$350
million if
i. They know the correct value of the shares is
$ 9.00$9.00?

Added by Martin B.

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