Life Turn Co. is a pharmaceutical company. Life Turn has no debt and 100 million shares outstanding. To build a new warehouse to support the production of the new medicine, the company must raise $400 million. To raise debt, managers of Life Turn estimate that the present value of financial distress costs will exceed tax benefits by $50 million. On the other hand, given that managers know the correct share price, if the company chooses to raise $400 million by issuing equity, Life Turn will face a lemons problem. Suppose that if Life Turn issues equity, the share price will remain at $16. To maximize the long-term share price of the firm once its true value is known, which of the following choice the managers will choose, i.e. to issue equity or borrow the $400 million.

If they know the correct value of the shares is $18?

Answer rating: 100% (QA)

To determine whether Life Turn Co should issue equity or borrow the 400 million we need to compare t... View the full answer