creating an app that improves how households manage their rubbish. This app project

delivers tomorrow a cash flow of $1$ million $($good state$)$ or $250,000($bad state$).$ If you put

an extra effort in developing the app, the probability of the good state is $75\%$ and the

probability of the bad state is $25\%,$ however your extra effort is equivalent to a personal

negative cash flow of $-150,000($i$.$e$,$ the project$$s cash flows will not be affected, but only

you will have this negative cash flow in case of effort$).$ If you do not put an extra effort, the

probabilities are reversed $($i$.$e$.,$ the probability of the good state is $25\%$ and the probability

of the bad state is $75\%)$ but at least you do not have a personal negative cash flow. The

financing of the project today costs $500,000$ and you have no wealth, i$.$e$.,$ you need

outside investors to finance your project. Furthermore, outside investors cannot verify

whether you are making an effort or not. Assume a zero discount rate.

a$)$ Without doing any calculations, describe in detail the conflict of interest highlighted in

the question and how to mitigate it$.$

$[9$ marks$]$

b$)$ Can the app project be financed with equity only? Justify your answer with

calculations.

$[8$ marks$]$