# hw1 - Problem Set 1 Econ 138 This Problem Set covers the MM...

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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 risk-averse rather than risk-neutral. (Remember: The MM Theorem does not rely on the assumption that investors are risk-neutral but holds for any risk preferences.) The last questions demonstrate how we can use the MM Theorem in a risk-averse 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 fi nancing options: (1) a loan with a face value of \$55 , 000 and equity fi 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 risk-neutral.

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