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Info Systems 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 $11.75 or $10.75 per share. Investors view both possibilities as equally? likely, so the shares currently trade for $11.25. IST must raise $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 million, the present value of financial distress costs will exceed any tax benefits by $15 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 million by issuing equity.

a. Suppose that if IST issues? equity, the share price will remain at

$11.25.

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

million if

i. They know the correct value of the shares is

$10.75??

?(Select the best choice? below.)

Managers should issue equity for

$350

million.

Managers should borrow the

$350

million.

Suppose that if IST issues? equity, the share price will remain

$11.25.

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

million if

ii. They know the correct value of the shares is

$11.75??

?(Select the best choice? below.)

Managers should issue equity for

$350

million.

Managers should borrow the

$350

million.

b. Given your answer to part

?(a?),

what should investors conclude if IST issues? equity? What will happen to the share? price? ?(Select the best choice? below.)

If IST issues? equity, investors would conclude IST is overpriced and the share price would decline to

$11.25.

If IST issues? equity, investors would conclude IST is underpriced and the share price would rise to

$11.75.

If IST issues? equity, investors would conclude IST is underpriced and the share price would rise to

$11.25.

If IST issues? equity, investors would conclude IST is overpriced and the share price would decline to

$10.75.

Given your answer to part

what should investors conclude if IST issues? debt? What will happen to the share price in that? case? ?(Select the best choice? below.)

If IST issues? debt, investors would conclude IST is undervalued and the share price would rise to

$11.60.

If IST issues? debt, investors would conclude IST is undervalued and the share price would rise to

$11.25.

If IST issues? debt, investors would conclude IST is overvalued and the share price would decline to

$11.60.

If IST issues? debt, investors would conclude IST is overvalued and the share price would decline to

$11.25.

How would your answers change if there were no distress? costs, but only tax benefits of? leverage? ?(Select the best choice? below.)

There would be no change from the answers above.

All firms would issue debt and the share price would rise above

$11.25

on the announcement.

C.All firms would issue equity at a share price of

$10.75.

D.All firms would issue debt and the share price would fall below

$11.25

on the announcement.

E.All firms would issue equity at a share price of

$11.25.

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