a) At time =-1, a publicly listed firm owns some assets in place and a positive NPV project in which the firm could invest at time t=0. However, both the firm's managers and the outside investors do not know the precise values of the firm's assets in place and of the NPV of the project. The firm has no financial slack and must issue equity to new shareholders to invest in the project at time t=0. All the assumptions of Myers and Majluf's (1984) pecking order model hold. At time t=0, the firm's management receive private information about the values of the firm's assets-in-place and the NPV of the investment project. When deciding whether to issue equity and go ahead with the new project, the management act in the best interest of the passive, existing shareholders. The key financial information about the firm and its investment opportunity can be found in the table below. Firm type High quality Low quality Probability of firm type 0.40 0.60 Financial slack (in £ million) Assets-in-place (in £ million) 650 200 Initial outlay of new project (in £ 95 million) 95 NPV of new project (in £ million) 30 16 (i) Derive a rational expectations equilibrium (REE) in which investors' rational beliefs at time t=0 are consistent with the management's actions at time t=0. Show your calculations in detail and comment on your results. (ii) What would the equilibrium outcome of the model be if the firm's financial slack was equal to 20 (S=20)? Show your calculations in detail and comment on your results. (iii) In this numerical example of the pecking order theory, four variables are considered: the NPV of the project, the investment required to go ahead with the project, the assets-place and the financial slack. Briefly explain how each of these variables is related to the likelihood that a firm does not undertake a project with a positive NPV. Word limit: 150 words]
a) At time =-1, a publicly listed firm owns some assets in place and a positive NPV project in which the firm could invest at time t=0. However, both the firm's managers and the outside investors do not know the precise values of the firm's assets in place and of the NPV of the project. The firm has no financial slack and must issue equity to new shareholders to invest in the project at time t=0. All the assumptions of Myers and Majluf's (1984) pecking order model hold. At time t=0, the firm's management receive private information about the values of the firm's assets-in-place and the NPV of the investment project. When deciding whether to issue equity and go ahead with the new project, the management act in the best interest of the passive, existing shareholders. The key financial information about the firm and its investment opportunity can be found in the table below. Firm type High quality Low quality Probability of firm type 0.40 0.60 Financial slack (in £ million) Assets-in-place (in £ million) 650 200 Initial outlay of new project (in £ 95 million) 95 NPV of new project (in £ million) 30 16 (i) Derive a rational expectations equilibrium (REE) in which investors' rational beliefs at time t=0 are consistent with the management's actions at time t=0. Show your calculations in detail and comment on your results. (ii) What would the equilibrium outcome of the model be if the firm's financial slack was equal to 20 (S=20)? Show your calculations in detail and comment on your results. (iii) In this numerical example of the pecking order theory, four variables are considered: the NPV of the project, the investment required to go ahead with the project, the assets-place and the financial slack. Briefly explain how each of these variables is related to the likelihood that a firm does not undertake a project with a positive NPV. Word limit: 150 words]
A First Course in Probability (10th Edition)
10th Edition
ISBN:9780134753119
Author:Sheldon Ross
Publisher:Sheldon Ross
Chapter1: Combinatorial Analysis
Section: Chapter Questions
Problem 1.1P: a. How many different 7-place license plates are possible if the first 2 places are for letters and...
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![a) At time t=-1, a publicly listed firm owns some assets in place and a positive
NPV project in which the firm could invest at time t=0. However, both the firm's
managers and the outside investors do not know the precise values of the firm's
assets in place and of the NPV of the project. The firm has no financial slack
and must issue equity to new shareholders to invest in the project at time t=0.
All the assumptions of Myers and Majluf's (1984) pecking order model hold. At
time t=0, the firm's management receive private information about the values
of the firm's assets-in-place and the NPV of the investment project. When
deciding whether to issue equity and go ahead with the new project, the
management act in the best interest of the passive, existing shareholders. The
key financial information about the firm and its investment opportunity can be
found in the table below.
Firm type
High quality
Low quality
Probability of firm type
0.40
0.60
Financial slack (in £ million)
Assets-in-place (in £ million)
650
200
Initial outlay of new project (in £ 95
million)
95
NPV of new project (in £ million)
30
16
(i) Derive a rational expectations equilibrium (REE) in which investors'
rational beliefs at time t=0 are consistent with the management's actions
at time t=0. Show your calculations in detail and comment on your results.
(ii) What would the equilibrium outcome of the model be if the firm's
financial slack was equal to 20 (S=20)? Show your calculations in detail
and comment on your results.
(iii) In this numerical example of the pecking order theory, four variables
are considered: the NPV of the project, the investment required to go
ahead with the project, the assets-place and the financial slack. Briefly
explain how each of these variables is related to the likelihood that a firm
does not undertake a project with a positive NPV. [Word limit: 150 words]](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F85963db8-918e-4b79-bdc4-775d0c35cd44%2F3098bda0-f75c-4874-a802-cec6978f650d%2Fy46x2rd_processed.png&w=3840&q=75)
Transcribed Image Text:a) At time t=-1, a publicly listed firm owns some assets in place and a positive
NPV project in which the firm could invest at time t=0. However, both the firm's
managers and the outside investors do not know the precise values of the firm's
assets in place and of the NPV of the project. The firm has no financial slack
and must issue equity to new shareholders to invest in the project at time t=0.
All the assumptions of Myers and Majluf's (1984) pecking order model hold. At
time t=0, the firm's management receive private information about the values
of the firm's assets-in-place and the NPV of the investment project. When
deciding whether to issue equity and go ahead with the new project, the
management act in the best interest of the passive, existing shareholders. The
key financial information about the firm and its investment opportunity can be
found in the table below.
Firm type
High quality
Low quality
Probability of firm type
0.40
0.60
Financial slack (in £ million)
Assets-in-place (in £ million)
650
200
Initial outlay of new project (in £ 95
million)
95
NPV of new project (in £ million)
30
16
(i) Derive a rational expectations equilibrium (REE) in which investors'
rational beliefs at time t=0 are consistent with the management's actions
at time t=0. Show your calculations in detail and comment on your results.
(ii) What would the equilibrium outcome of the model be if the firm's
financial slack was equal to 20 (S=20)? Show your calculations in detail
and comment on your results.
(iii) In this numerical example of the pecking order theory, four variables
are considered: the NPV of the project, the investment required to go
ahead with the project, the assets-place and the financial slack. Briefly
explain how each of these variables is related to the likelihood that a firm
does not undertake a project with a positive NPV. [Word limit: 150 words]
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