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. Suppose Pompeia wants to finance her education, plus buy a home. She needs to borrow $400,000, and the risk free rate is 5%. She
. Suppose Pompeia wants to finance her education, plus buy a home. She needs to borrow $400,000, and the risk free rate is 5%. She can try to obtain financing by issuing either debt or equity. Pompeias job pays a salary of $60,000 per year. If she works hard, she has a 50 percent chance of getting a promotion and an increase in her salary to $140,000. If Pompeia devotes minimal effort to her job, her salary will remain at $60,000. Pompeias disutility of working hard is $36,000. Everyone is risk neutral. Assume asymmetric information.
- How much is Pompeias annual cost of funds?
- Hard work generates how much surplus? Explain.
- In an equity sale, Pompeia must try to sell at least a 1/5 share. Why?
- If savers were to accept a 1/5 share, would Pompeia work hard? Show your computations. How big a share do savers require?
- In equilibrium, does she obtain financing by using debt or by using equity? Show your computations. Is the equilibrium efficient?
- Describe the asymmetric information problem: Who cant observe what?
- Would savers accept a 1/5 share if information were symmetric? Explain.
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