1) Statistically, teenage drivers are more probable to have the automobile accident than adult drivers. Accordingly, insurance companies charge higher insurance premiums for teenager drivers. Assume one insurance company decided to charge teenagers and adults same premium based on average risk of the accident among both groups. By using your knowledge of problems related with asymmetric information, describe whether you think this insurance company will be lucrative.
2) Kimble Electronics is small toy producing company with total assets of $1.5 million. Company has an opportunity to do leveraged recapitalization that would involve borrowing 30% to 50% of ?rm’s assets at a rate of 9% per year. Furthermore, ?rm’s annual return on its total investment in assets differs from 4% to 15%. Analyze effects of financial leverage on rate of return earned on Kimble’s equity if firm borrows 30% or 50% of its assets.