Asymmetric Information and Capital Structure Essay

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50 a share if IST issues equity.

c. If IST issues debt, the share price can stay the same and the company has extra tax benefits.

d. The answers would not change, it would just make it more feasible to borrow the money.

Managers would choose to borrow the $500 million because of the debt tax shield and because it would give them more control over their company rather than issuing equity because if they issue equity, they can't control the cost of the shares, it might drop below the current possibility of $12.50 per share and also, they would possibly have someone come in and buy out the company by buying up large quantities of shares to get a majority of the shares.

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Of course, they would also face the possibility of losing control of the company if they didn't pay (weren't able to pay) the debt payments, but the gamble would be slight, due to the variables. Future debt payments would be known and could be planned for. The interest payments for the debt can be taken off taxable income and so a company that is in a higher tax bracket could save a substantial amount in lower taxes. This could possibly cause a smaller cash-flow, which could work in the company's favor and make production tighter with less overage.

Therefore, my recommendation, given the above scenario, would be to….....

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