Q. An entrepreneur wants to undertake a project, which generates future revenue of 34 or 9 and requires an initial cost of 12. The cash flow from the project depends on the entrepreneur's level of effort. if he exerts an effort level 0<=e<=1. The project generates 34 or 9 with probability of e and 1-e respectively. This effort reduces the entrepreneur's utility by 20e^2. The entrepreneur can finance the project by issuing either debt or equity and can choose his effort level after debt or equity is issued.
a) Can the project be financed when the entrepreneur issues equity? What would be the value of all equity firms now?
b) Can the project be financed when the entrepreneur issues debt? is it optimal to issue debt? If the company issues debt to finance the project what would be the value of the company? What would be the value of the levered equiy?