Question An entrepreneur has to finance a project of fixed size I. The entrepreneur has cash-on-hand A, where A <1. To implement the project,

Question An entrepreneur has to finance a project of fixed size I. The entrepreneur has "cash-on-hand" A, where A 0, or fails, in which case it delivers a zero return. The probability of success depends on the effort exerted by the borrower: if the borrower exerts effort, the probability of success is equal to PH; if the borrower exerts no effort, the probability of success is equal to PL, where Ap = PH-PL >0. If the borrower exerts no effort, he also obtains a private benefit B > 0, while there is no private benefit when the borrower exerts effort. Define as R, the amount of profit going to the borrower, and as R, the amount of profit going to the lenders in case of success, where R = R + R. All the players are risk neutral. Lenders behave competitively, and both borrower and lenders receive zero if the project fails. (a) Write down the Net Present Value (NPV) of the project when the borrower exerts i) effort and ii) no effort. (10 marks) (b) What is the minimum level of R, such that the borrower exerts high effort? Show your work. (10 marks) (c) What is the minimum level of R such that lenders are willing to lend money to the borrower? Show your work. (10 marks) (d) Suppose A=0. Can the borrower obtain a loan from the lenders? Explain your answer. (20 marks) (e) Suppose the borrower considers issuing new securities (after having secured a first loan equal to I- A) to "deepen the investment". If undertaken, the new investment increases uniformly that is, independently of the effort exerted - the probability of success by a factor 7 > 0, with 0. Suppose the new investment is inefficient, that is, the expected increase in profit R is smaller than J. In this moral hazard framework, should the initial lenders (those who lent I- A) be worried about the issuing of new securities? Explain. (20 marks). (f) Let us continue with the framework introduced in point (e). Consider the case in which T=PH-PL. Should the initial lenders (ie., those who lent I- A) be worried about the issuing of new securities? Explain. (30 marks).