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3. Consider a firm that investors believe is one of two types, good or bad, with equal probability. Information is asymmetric in that managers of
3. Consider a firm that investors believe is one of two types, good or bad, with equal probability. Information is asymmetric in that managers of the firm know with cer- tainty the true type of the firm. The firm has access to a project which requires an immediate investment of $1 million. The objective of the managers is to maximize the intrinsic value of the existing shareholders' claims. The cash flow distribution of the firm, contingent on its investment decision and type, are presented below: Good Asset-in-place $1.25 million Project $1.2 million Bad $1 million $1.1 million Suppose that all agents are risk neutral (i.e., they only care about expected value) and the riskless rate of interest is 5%. If the firm is limited to equity financing, should it go ahead with the project? Why? 3. Consider a firm that investors believe is one of two types, good or bad, with equal probability. Information is asymmetric in that managers of the firm know with cer- tainty the true type of the firm. The firm has access to a project which requires an immediate investment of $1 million. The objective of the managers is to maximize the intrinsic value of the existing shareholders' claims. The cash flow distribution of the firm, contingent on its investment decision and type, are presented below: Good Asset-in-place $1.25 million Project $1.2 million Bad $1 million $1.1 million Suppose that all agents are risk neutral (i.e., they only care about expected value) and the riskless rate of interest is 5%. If the firm is limited to equity financing, should it go ahead with the project? Why
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