Study Guides (258,876)
CA (125,030)
UTM (5,134)
ECO (241)
ECO359H5 (14)
Sun (12)

Practice problem--it's very helpful ~

1 Page
100 Views

Department
Economics
Course Code
ECO359H5
Professor
Sun

This preview shows half of the first page. Sign up to view the full page of the document.
ECO359/2011UniversityofToronto
PracticeProblems6  DepartmentofEconomics
Page1of1

ECO 359 Practice Problems 6
1. An entrepreneur has access to a project, which generates future revenue of 20 or 4 and
requires an initial cost of 5. When he exerts an effort level AÐ>rás? for the project, the
project generates revenue 20 with probabilityA and revenue 4 with probability sFA. His
utility is reduced by sxA6. The initial cost must be financed by issuing either debt or equity.
The entrepreneur can choose his effort level at will after debt or equity is issued. Both the
entrepreneur and investors are risk neutral and there is no discounting.
(a) Can the project be financed when he issues debt?
(b) Can the project be financed when he issues equity?
2. Miranda is considering running for society-presidency. If she runs and is successful, she
becomes the society's president and gets a payoff of :Lstr. If she's unsuccessful, she
becomes vice-president and gets a payoff of :Lur. The fixed costs of running are F = 50.
The probability of the high outcome depends on the effort that Miranda puts in. Her effort is a
continuous variable in >rás?, and the probability of the high outcome is 2N::L:;LA, for
the low it is 2Nk:L:oLsFAä Now Miranda rather slacks off, since putting in the effort
is costly for her. To be precise, effort costs her ?:A;LvwA6ä
(a) Suppose Miranda has the funds to finance herself. Which effort level will she choose?
(b) Now suppose she seeks to finance her endeavors through credit (=debt). Assume
throughout that effort is non-contractible.
(i) Suppose the debt's face value has the risk-free amount. Show that a risk-free debt
contract would require that Miranda exerts effort ALs.
(ii) Now assume a risky debt contract. In the bad state, all goes to the debtor, 4Lur.
Verify that the debt's face value 4 as a function of A is
4Ltr EurA
Aä
(iii) Show that Miranda's optimal effort choice is AÛLsu or AÛLtu.
(c) Show that Miranda cannot finance her campaign with an equity contract. (In an equity
contract she would sell fraction = of future payoffs to her financier.)
www.notesolution.com

Loved by over 2.2 million students

Over 90% improved by at least one letter grade.

Leah — University of Toronto

OneClass has been such a huge help in my studies at UofT especially since I am a transfer student. OneClass is the study buddy I never had before and definitely gives me the extra push to get from a B to an A!

Leah — University of Toronto
Saarim — University of Michigan

Balancing social life With academics can be difficult, that is why I'm so glad that OneClass is out there where I can find the top notes for all of my classes. Now I can be the all-star student I want to be.

Saarim — University of Michigan
Jenna — University of Wisconsin

As a college student living on a college budget, I love how easy it is to earn gift cards just by submitting my notes.

Jenna — University of Wisconsin
Anne — University of California

OneClass has allowed me to catch up with my most difficult course! #lifesaver

Anne — University of California
Description
ECO3592011 UniversityofToronto PracticeProblems6 DepartmentofEconomics ECO 359 Practice Problems 6 1. An entrepreneur has access to a project, which generates future revenue of 20 or 4 and requires an initial cost of 5. When he exerts an effort level ) >HI? for the project, the project generates revenue 20 with probability) and revenue 4 with probability I . ). His $ utility is reduced by IN) . The initial cost must be financed by issuing either debt or equity. The entrepreneur can choose his effort level at will after debt or equity is issued. Both the entrepreneur and investors are risk neutral and there is no discounting. (a) Can the project be financed when he issues debt? (b) Can the project be financed when he issues equity? 2. Miranda is considering running for society-presidency. If she runs and is successful, she becomes the societys president and gets a payoff of : L IJH. If shes unsuccessful, she becomes vice-president and gets a payoff of : L KH. The fixed costs of running are F = 50. The probability of the high outcome depends on the effort that Miranda puts in. Her effort is a continuous variable in >HI?, and the probability
More Less
Unlock Document


Only half of the first page are available for preview. Some parts have been intentionally blurred.

Unlock Document
You're Reading a Preview

Unlock to view full version

Unlock Document

Log In


OR

Don't have an account?

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


OR

By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.


Submit