Assume the market is equally populated by two kinds of firms: one with profitable and one with unprofitable internal forecasts. Assume that all firms are equity financed, and that all profitable and unprofitable firm are identical except for profitability. Because of severe information asymmetry, investors cannot distinguish between types. The manager, however, as corporate insiders, know about their own type. The firms intrinsic values, which are common knowledge, are $150M and $50M for profitable and unprofitable firms, respectively. Partial marks are available for this question. Show all work to receive mark.

1. If the unprofitable firm needs to raise $30M to invest in a project that will payoff $40M next year, how much of the firms stake must it sell in order to raise the capital? Assume the project has a beta of 1 and the market is expected to return 10%. Show how to calculate
2. As a CEO of an unprofitable firm in the market, you must decide whether the firm raise funds via debt financing or equity financing. Choose your preferred financing method and show why you choice is better than the other option. Show how to calculate and explanation

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