16-28 - Info System Technology (IST) manufactures...

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Info System Technology (IST) manufactures microprocessor chips for use in appliances and other applications. IST has no debt and 100 million shares outstanding. The correct price for these shares is either $14.50 or $12.50 per share. Investors view both possibilities as equally likely, so the shares currently trade for $13.50. IST must raise $500 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 $500 million, the present value of financial distress costs will exceed any tax benefits by $20 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 $500 million by issuing equity. a. Suppose that if IST issues equity, the share price will remain #13.50. To maximize the long- term share price of the firm once its true value is known, would
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This note was uploaded on 08/22/2011 for the course ACCOUNTING 201 taught by Professor Stevejoseph during the Winter '11 term at Aarhus Universitet.

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16-28 - Info System Technology (IST) manufactures...

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