Question 3 (5 pts) A firm has an own funding capacity of A and wants to fund an efficient project which costs I (A 0 in case of success and nothing in case of failure. Since ex post behavior is not publicly observable, the firm may misbehave. The success probability is high pH if the firm behaves diligently and low PL( PH > PL) if it is lax, in which case it earns a private gain B. If the firm wants to obtain funding from the financial market, it has to pay a return Ru to the potential investors who are risk-neutral and not able to monitor the borrowers. Investors have access to an alternative investment yielding a gross expected return1+r. 1. State the efficiency of the project in mathematical terms and explain in plain words. 2. Deduce the pledgeable expected income which can be promised to investors by the firm. 3. Explain in economic terms why the firm is not able to pledge the full return R ? 4. The investors decide to fund an amount I. Assuming that the re- turn to investors incentivizes the firm to behave diligently and using the participation constraint of the uninformed investors prove that the firm may be rationed even if the project is socially efficient? 5. Using the above result, explain clearly the economic reason why the project cannot be exclusively funded by external uninformed capital Question 3 (5 pts) A firm has an own funding capacity of A and wants to fund an efficient project which costs I (A 0 in case of success and nothing in case of failure. Since ex post behavior is not publicly observable, the firm may misbehave. The success probability is high pH if the firm behaves diligently and low PL( PH > PL) if it is lax, in which case it earns a private gain B. If the firm wants to obtain funding from the financial market, it has to pay a return Ru to the potential investors who are risk-neutral and not able to monitor the borrowers. Investors have access to an alternative investment yielding a gross expected return1+r. 1. State the efficiency of the project in mathematical terms and explain in plain words. 2. Deduce the pledgeable expected income which can be promised to investors by the firm. 3. Explain in economic terms why the firm is not able to pledge the full return R ? 4. The investors decide to fund an amount I. Assuming that the re- turn to investors incentivizes the firm to behave diligently and using the participation constraint of the uninformed investors prove that the firm may be rationed even if the project is socially efficient? 5. Using the above result, explain clearly the economic reason why the project cannot be exclusively funded by external uninformed capital