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You are evaluating a loan request of $3.5 million from Precise Corp and the bank will require an expected return of 4.0 percent per annum. The firm has an existing debt repayment obligation of $4.5 million. It has $2.0 million in equity. The firm has two projects, A and B. An investment in A will yield a payoff of $5.5 million with a probability of 0.8 and $3.0 million with a probability of 0.2. An investment in B will yield a payoff of $8.0 million with a probability of 0.4 and $0.5 million with a probability of 0.6. The firm has assets-in-place that generates $5.0 million with a probability of 0.75 and $1.0 million with a probability of 0.25. Assume that the distributions of payoffs for A and B are common knowledge, and the payoff from A is statistically independent of the payoff for B. However, as a bank officer, you cannot observe the firm's project choice.
a) What rate should the bank charge in order to breakeven? Given this rate will a Nash equilibrium result?
b) On presenting your results to the chief credit officer she asks if you have considered the analyst's report that states that the firm is considering paying a dividend equal $2.0 million immediately. Will your recommendation change? Show calculations.
c) What are alternatives that are available to approve the loan given your answer to part b? Be specific and concise. No calculations are required
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