Although severely damaged by the collision and already

C is the OA.
Can anyone explain why in option B -
Although it had been severely damaged by the collision and was already sinking,the coast guard arrived at the freighter in time to save the crew.
the pronoun 'it ' is a pronoun reference error. Doesn't hte 'it' clearly refer to the freighter.

Although it had been severely damaged by the collision and was already sinking, the coast guard [...]
"it" does not properly refers to freighter. The first half is an introductory modifier and modifies the noun that immediately follows the comma.

Paul,
This is my understanding of misplaced modifiers.
When a sentence begins with a phrase, that phrase is supposed to modify the noun or the pronoun that immediately follows the phrase. Otherwise its a misplaced modifier.
There are two ways to correct this.
1. Place the noun or pronoun immediately after the phrase.
2. Change the phrase to a clause by introducing a subject so that it is no longer necessary for the first half of the sentence to modify the noun following it.

Eg from Princeton Review -
Although it is not quite as liquid an investment as a money-market account, financial experts recommend a certificate of deposit for its high yield.
In the above sentence, 'it' clearly refers to the certificate of deposit and not to the financial experts.

So why then do we say that the 'it' in our example doesn't have a clear referrent.
Thanks.

In your given example, "it" refers to certificate of deposit because it is the only singular noun following the introductory modifier. However, I do not like that sentence since the modifier does not immediately modifies the noun following the clause.

My choice is B
Correct me if my understanding is not right.

'Damaged by' seems to be a better usage when stating the cause of damage. 'Damage in' seems to fit well when the time factor comes into play.

Both are right, but differs in context they should be used.

it all depends on the subect in question. when two or more elements are mutually involved in something, we use "damaged in".
--> Iraqi Islamic shrine damaged in attack.
--> Nuclear missile damaged in submarine base mishap.

and when the subject itself is causing the action (one sided) then we use "damaged by"
--> shops damaged by the vandals.
--> a mind damaged by addiction.
--> Notes on Emergency Drying of Coated Papers Damaged by Water

(C) it is ! The sentence should begin with naming the freighter as the pronoun 'it' could has no antecedent noun. (D) is out as it was also already sinking is unescessary.