An entrepreneur needs funds for a project. She has funds of her own, but not enough to cover the required investment of $200. If the entrepreneur doesn’t misbehave, the project will succeed with probability 1/2, yielding a gross return of $500 in one year. With probability 1/2, it fails and yields nothing. If the entrepreneur misbehaves, on the other hand, she obtains a
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An entrepreneur needs funds for a project. She has funds of her own, but not enough to cover the required investment of $200. If the entrepreneur doesn’t misbehave, the project will succeed with probability 1/2, yielding a gross return of $500 in one year. With probability 1/2, it fails and yields nothing. If the entrepreneur misbehaves, on the other hand, she obtains a private benefit of $30 while lowering the probability of success to 1/3. Potential financiers require an expected gross return of $1.05 in one year on $1 loaned today–that is, they will lend the present value of the expected return in one year, using an interest rate of .05 to get the present value. Find the net present value of the project if the entrepreneur behaves and the net present value if she misbehaves.
A contract between the financier and the entrepreneur will specify the amount each will receive if the project succeeds. They will total to $500. Each will get 0 if the project fails, of course.
What is the minimum amount the entrepreneur must receive if the project succeeds for her to choose good behavior? Explain.
What is the maximum amount she will be able to borrow? Explain in detail.
Then What is the amount of funds of her own she must put into the project if she is to get financing?
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