Where the risk-neutral probability of success

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Reference no: EM132008792

Bill Guerin, an entrepreneur, has a project available for investment with two pro-duction techniques, Safe and Risky, both requiring an initial investment of $100. Next year, the Safe technique provides a payoff of $120 with certainty, and the Risky technique pays $124 if successful, but only $94 if unsuccessful, where the risk-neutral probability of success is ½. The risk-free rate is 5%.

a) Can Guerin obtain a $100 loan to be repaid next year to finance the project at the risk-free rate?

b) What is the NPV for the bank if it charges 15% interest on the loan?

c) What is the NPV for the bank if it charges 17% interest on the loan?

d) Suppose the bank has a monopoly on providing financing. Discuss how parts b) and c) relate to the bank’s decision about what interest rate to charge.

Reference no: EM132008792

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