Question 2 [20 points) Consider an economy with three dates {t=0, 1, 2}. A startup firm that produces an application for

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Question 2 20 Points Consider An Economy With Three Dates T 0 1 2 A Startup Firm That Produces An Application For 1 (86.65 KiB) Viewed 36 times

Question 2 [20 points) Consider an economy with three dates {t=0, 1, 2}. A startup firm that produces an application for mobile internet access has assets in place that generate an output (profit) of either $120 in state L or $200 in state H at t=2. Both states are equally likely. At t=1, the firm can implement another project. The investment costs are $220 and the new project delivers an output of SX in state L and $340 in state H at t=2. The firm wants to issue equity to a venture capitalist to finance the new project. Both the entrepreneur of the startup firm and the venture capitalist are risk neutral. They maximize their expected payoff. The interest rate is r=0%. For questions (a) to (d), assume X=100. (a) What is the t=0 value of the firm (i) without and (ii) with the project? [2p] (b) What percentage of equity does the entrepreneur need to sell so as to finance the investment cost of $220 for the new project at t=1? [1p) Now suppose prior to selling equity the entrepreneur privately learns the true state of t=2 at t=l. This assumption holds for all subsequent questions. At t=l does the entrepreneur sell equity in both states? [3p] What is the t=l value of the firm if equity is sold at t=1? [2p] (d) (e) (1) Determine the set {X} such that there is equity issuance in both states at t=1? [6] For the above set of {X}, what is the tel value of the firm if equity is issued in both states? [2p] From a welfare and net present value (NPV) perspective, should the entrepreneur who knows the true state raise equity and invest in the project in both (L and H) states? If it is not socially efficient, what is the rationale for the entrepreneur still to do that? [4p)