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Problem Set 1 Econ 138
January 29, 2008
This Problem Set covers the MM Theorem. After walking through a basic calculation, we
ask whether things change if we assume that investors are riskaverse rather than riskneutral.
(Remember: The MM Theorem does
not
rely on the assumption that investors are riskneutral
but holds for any risk preferences.) The last questions demonstrate how we can use the MM
Theorem in a riskaverse world to calculate rates of returns / discount rates.
An entrepreneur would like to start a company, called BCFB, producing
Better Corporate
Finance Books
, but has no own funding. The project has stochastic future returns, realized
next period (at
t
= 1), that are uniformly distributed between $20
,
000 and $200
,
000,
R
∼
u
[20
,
000; 200
,
000].
The entrepreneur has two
f
nancing options: (1) a loan with a face value of $55
,
000 and
equity
f
nancing for the remainder or (2) a loan with a face value of $60
,
000 andd equity for
the remainder. The interest rate is 10%, and all investors are riskneutral.
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This note was uploaded on 04/02/2008 for the course ECON 138 taught by Professor Malmendier during the Spring '08 term at University of California, Berkeley.
 Spring '08
 Malmendier

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