Question

0. Consider the following fixed-investment model. An entrepreneur has cash A and can invest I1 > A in a project. The project’s payoff is R1 in the case of sucess and 0 otherwise. The entrepreneur can work, in which case her private benefit is 0 and the probability of success is pH , or shirk, in which case her private benefit is B1 and the probability of success pL. The project has positive net present value (pHR1 > I1), but will not be financed if the contract induces the entrepreneur to shirk. The (expected) rate of return demanded by investors is 0. What is the threshold value of A such that the project is financed?

Answer 1