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(impact of entrepreneurial risk aversion). Consider the fixed-investment model developed in this chapter: an entrepreneur has cash amount A and wants to invest 1>A into a project. The project yields R > 0 with probability p and 0 with probability 1 - p. The probability of success is pH if the entrepreneur works and pL = pH - ?p (?p > 0) if she shirks. The entrepreneur obtains private benefit B if she shirks and 0 otherwise. Assume that
(Suppose that pLR + B so the project is not financed if the entrepreneur shirks.)
(i) In contrast with the risk-neutrality assumption of this chapter, assume that the entrepreneur has utility for consumption c:
(Assume that A ≥c0 to ensure that the entrepreneur is not in the "-∞ range" in the absence of financing.) Compute the minimum equity level A for which the project is financed by risk-neutral investors when the market rate of interest is 0. Discuss the difference between pH = 1 and pH
(ii) Generalize the analysis to risk aversion. Let u(c) denote the entrepreneur's utility from consumption with u> 0, u.
What is the Acme Company’s weighted average cost of capital if its cost of before-tax debt is 8% (20% of overall capital structure), its cost of preferred stock is 9.5% (20% of capital structure) and is cost of internal equity is 15.5% (60% of the ca..
A portfolio is invested 14 percent in Stock G, 54 percent in Stock J, and 32 percent in Stock K. The expected returns on these stocks are 9 percent, 15 percent, and 18 percent, respectively. What is the portfolio's expected return?
Maverick Manufacturing, Inc., must purchase gold in three months for use in its operations. Maverick’s management has estimated that if the price of gold were to rise above $1,610 per ounce, the firm would go bankrupt. Should the company buy a call o..
When Marilyn Monroe died, ex-husband Joe DiMaggio vowed to place fresh flowers on her grave every Sunday as long as he lived. The week after she died in 1962, a bunch of fresh flowers that the former baseball player thought appropriate for the star c..
Eisenhower Communications is trying to estimate the first-year net operating cash flow (at Year 1) for a proposed project. The financial staff has collected the following information on the project: What is the project's operating cash flow for the f..
The shares Bond Index fund (TLT) has a mean and annual standard deviation of returns of 7% and 10%, respectively. What is the 66% confidence interval for the returns on TLT?
You plan to buy the house of your dreams in 5 years. You have estimated that the price of the house will be $119,644 at that time. You are able to make equal deposits every month at the end of the month into a savings account at an annual rate of 3.9..
Changing compounding frequency Using annual, semi annual, and quarterly compounding periods for each of the following, (1) calculate the future value if $5,000 is deposited initially, and (2) determine the effective annual rate (EAR).
Howard Hane had taken out a $130,000 fire insurance policy for his new restaurant at a rate of $.82 per $100. Nine months later, Howard canceled the policy and decided to move his store to a new location. The cost of the premium to Howard is (use the..
Deci-Bell, Inc. is producing new headphones. Deci-Bell Inc. has a base level of sales of 312,464 units. Sales price per unit is $148.61 and variable cost per unit is $61.52. Total annual operating fixed costs are $6,294,441.
Cheeseburger and Taco Company purchases 11,789 boxes of cheese each year. It costs $11 to place and ship each order and $9.61 per year for each box held as inventory. The company is using Economic Order Quantity model in placing the orders. What is t..
What is the equivalent annual savings from the purchase if Gluon uses straight-line depreciation?- The opportunity cost of capital is 11%, and the firm's tax rate is 40%.
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