Consider a firm with zero debt and 100 million shares outstanding. - The shares currently trade for $21. - The firm 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 the firm 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, the firm faces the asymmetric information problem if it attempts to raise the $500 million by issuing equity. (a) How would the share price change compared to the current one, $21, if the firm issues equity? Why? (b) Suppose the share price falls to $20 when the firm announces its plan to issue new equity. Would nanagers choose to issue equity or borrow the $500 million if they know the correct value of the shares s $19 ? (c) What is the benefit (or cost) per share of each of the transactions? Consider a firm with zero debt and 100 million shares outstanding. - The shares currently trade for $21. - The firm 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 the firm 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, the firm faces the asymmetric information problem if it attempts to raise the $500 million by issuing equity. (a) How would the share price change compared to the current one, $21, if the firm issues equity? Why? (b) Suppose the share price falls to $20 when the firm announces its plan to issue new equity. Would nanagers choose to issue equity or borrow the $500 million if they know the correct value of the shares s $19 ? (c) What is the benefit (or cost) per share of each of the transactions
