If the original sentence stated "Rather than confining an animal to cages, the zoo's lion currently lives...." which shows that both are singular, then how would an appropriate answer look?
If option C was modified to say "the zoo is currently housing a lion in an environment that it specially designed to mimic its natural habitat", that would be incorrect of course because the antecedent isn't clear for it or its. I'm guessing the correct answer would word it differently so that the words "zoo" and "lion" aren't repeated.
I assume even if one of the "it" was removed, it still wouldn't be correct. For example, "the zoo is currently housing a lion in an environment that it specially designed to mimic the animal's natural habitat."