1. Virgil can choose either a safe or a risky project. To keep things simple, lets say either project costs $100. A safe project yields $114 with certainty, while a risky project is equally likely to yield $208 or zero. Virgil needs financing for 50 percent of the cost of his project. Lenders cannot observe his choice of project. Everyone is risk neutral, and the risk-free rate is 6%.

1. If Virgil were to sell $50 worth of bonds with face value equal to $53, in which project would he invest? Justify your answer. How much would bondholders get paid, on average?

2. How much face value would Virgil need to offer lenders in order to sell $50 worth of bonds?

3. Is Virgil willing to offer the face value required to sell bonds? Explain.

4. Is Virgil willing to finance a project by selling shares? Are savers willing to purchase his shares? Does financing with equity yield an efficient equilibrium?