IntroductionCapital structure is a term used to refer to the fraction of debt and equity that constitutes the total capital of a company. The cost of debt is the amount above the borrowed amount that lenders charge the business in the form of interest. Advantages are associated with each financing criterion. For example, using debt to finance a project allows a company to benefit from a tax shield on interest. This means that interest paid on debt is deducted from taxable income, which serves to reduce the cost of financing as opposed to equity financing. The expenses associated with issuing debt securities are lower and managers are forced to allocate funds to more profitable projects in order to protect their careers. However, the use of debt has the disadvantage of plunging the company into a difficult financial situation by incurring additional costs for servicing the debt when the company is going through a difficult financial period (Parrino, R. & Kidwell, DS, 2009).28 a). Assuming that IST's stock price will remain at $13.50 after the stock issuance and that: i) Management knows that the correct value of the stock is $12.50, the company has needed $500 million to finance the project. If shares are issued to obtain the funds, then 37 million shares must be issued: $500 million / $13.50 = 37 million. However, the stock price of $13.50 includes a $1 premium, so the total profit to the company due to the share premium. is 37m x $1 = $37m. This works out to $0.27 per share. This can be represented as: 12.50 x 100 + 500 = 12.77100 + (500 /13.50). The par value is $12.50, 12.77 – 12.50 = 0.27, which is the premium per share. The cost of borrowing is $20 million and the company will compare the cost of borrowing $20 million with the profit of $37 million from issuing shares at a premium. The best choice is ...... middle of paper ...... an advantage and management would prefer it to debt financing. If the cost of borrowing is zero and shares can only be issued at a discount, managers will issue debt to avoid the additional cost of equity financing. However, investors seek to maximize their monetary value by purchasing shares at the lowest possible price the company is willing to offer. In the absence of advantages arising from equity financing, managers will resort to issuing debt since it is free (Berk & Demarzo 2011). References Berk & Demarzo, 2011. P. 213-214. Financial distress, managerial incentives and information...Pearson Education, Inc Publishing.Ricardo N. Bebczuk, 2003. P. 37-52Asymmetric information in financial markets: introduction and applications. Cambridge University Press. Xin Chang et al, 2011. P. 7. Capital structurehttp://www.bm.ust.hk/fina/staff/Dasgupta/Chang_Dasgupta_Hilary.pdf)