What is the average profit on an investment project

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Reference no: EM131220974

See given figure.
Assume as before that a firm makes the promised payment on a bond only if its project succeeds.

a. Suppose the government guarantees the firms' bonds: it makes the promised payment if either firm defaults. Can both firms sell bonds? What payments must they promise?

b. What is the average cost to the government of guaranteeing a bond, assuming it does so for each firm?

c. What is the average profit on an investment project, assuming both firms finance their projects with government-guaranteed bonds?

d. Which is higher-the average cost of a bond guarantee [part (b)] or the average profit on a project [part (c)]? In light of this comparison, do the guarantees promote economic efficiency? Explain why or why not.

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Reference no: EM131220974

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