Distressed Automotive Corp (DAC) has incurred large losses over the last few yea
ID: 2622606 • Letter: D
Question
Distressed Automotive Corp (DAC) has incurred large losses over the last few years and has $2 B in existing tax-loss carry forwards. Securities analysts estimate it will take several years to generate $2 B in earnings (i.e. no taxes will be paid on earnings in the immediate future). DAC already has a moderate amount of debt in the capital structure, leading debt investors to question their ability to repay their obligations. The firm needs to issue securities for an upcoming positive NPV project. Assuming taxes are 40%, what type of security should they issue?
A.If there are no information asymmetries, DAC should issue equity to fund their investment.
B. If there are no information asymmetries, DAC should issue debt to fund their investment.
C.If information asymmetries are very high and they exceed the costs of financial distress, DAC should issue debt to fund their investment.
D. Both A and C are correct.
E. Both B and C are correct
Explanation / Answer
D. Both A and C are correct.