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The Merriweather Industries has an investment opportunity which requires $200 at t = 1 and will pay off at t = 2.At t = 0 it is uncertain about the probability distribution of the random payoff of the project since the payoff depends on a state of nature which will be revealed privately to the management at t = 1 before making a decision to invest in the project.At t = 0, the firm has a belief that there is an equal probability that the state will be good or bad at t= 2.In the good state, the project will pay off $450 with probability 0.8 and zero with probability 0.2.In the bad state, the project will pay off $300 with probability 0.8 and zero with probability 0.2.At t = 0, the firm needs raw materials supplies of $40 from a supplier who agrees to extend a trade credit so that the firm pays back the $40 plus the agreed-upon interest at t = 2.It is known at t = 0 that the interest rate between t = 1 and t = 2 will be 8%.Moreover, the time between t = 0 and t = 1 is so short so that discounting can be ignored.Jim Merriweather, the CEO, suffers a personal cost of $10 to initiate the project.The firm has two alternatives: borrow $200 in the spot market after learning the state of nature, or purchase a loan commitment at t = 0 prior to knowing the state of nature which would entitle it to borrow $200 at t = 1.Everybody is risk neutral, and the bank and trade creditors provide credit at a competitive term.
-As a bank lending officer, what interest rate should you charge in order to break-even?

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The Merriweather Industries has an investment opportunity which requires $200 at t = 1 and will pay off at t = 2.At t = 0 it is uncertain about the probability distribution of the random payoff of the project since the payoff depends on a state of nature which will be revealed privately to the management at t = 1 before making a decision to invest in the project.At t = 0, the firm has a belief that there is an equal probability that the state will be good or bad at t= 2.In the good state, the project will pay off $450 with probability 0.8 and zero with probability 0.2.In the bad state, the project will pay off $300 with probability 0.8 and zero with probability 0.2.At t = 0, the firm needs raw materials supplies of $40 from a supplier who agrees to extend a trade credit so that the firm pays back the $40 plus the agreed-upon interest at t = 2.It is known at t = 0 that the interest rate between t = 1 and t = 2 will be 8%.Moreover, the time between t = 0 and t = 1 is so short so that discounting can be ignored.Jim Merriweather, the CEO, suffers a personal cost of $10 to initiate the project.The firm has two alternatives: borrow $200 in the spot market after learning the state of nature, or purchase a loan commitment at t = 0 prior to knowing the state of nature which would entitle it to borrow $200 at t = 1.Everybody is risk neutral, and the bank and trade creditors provide credit at a competitive term.
-As a bank lending officer, what interest rate should you charge in order to break-even?

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