Dain the CEO of a design firm, can invest $28 million in a project that will give a single cash inflow of $39 million in one year if Anna chooses to devote her full effort to the project (“work”).  Dain’s utility from the project is the payoff she receives from its cash flow. She is also a successful amateur artist and can choose to spend part of her time on this relaxing activity instead of the project (“shirk”). If she does this, the project will give a single cash inflow of $33 million in one year. Dain’s disutility from giving up her artistic activities to give her full effort to the project is $3m.    Assume Dain has no personal wealth and the project should be entirely financed by outside investors. Anna, and every potential investor in Dian’s project, is risk-neutral. The discount rate is zero.  Suppose Dian finances the project with outside equity, and the investors believe she will choose to work. 

1. a. Assume now the investors are aware of Dian’s artistic activity. What proportion of equity will they demand? What will Dian’s utility be if she chooses to shirk?

b. Suppose Dian can finance the project with debt. What will be the face value of the debt? What will Dian’s utility be, if she chooses to work? What will it be if she chooses to shirk?                                                                                                    

2. c. (i)  Explain the agency cost of outside equity with reference to your answers to parts (a) to (c) above. (160 words) 
3. (ii)  Who bears this cost? Explain.

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a i They will request the profit on return on 17 million cash inflow in one year in suitable proport... View the full answer