Genoma Inc. faces the need to raise external funds to undertake some new investment opportunities. By investing $100M Genoma will generate a gross return of $140M for sure and the market knows that. Unfortunately, Genoma has no internal funds and, because of the nature of the business, has to raise funds by issuing equity. The problem is that the market does not know whether the current value of Genoma assets is $100M or $20M, and regards both outcomes as equally likely. The managers of Genoma do know the true value, but they cannot reveal it, because this will jeopardize their success. Assume that investors are risk neutral and that the proper discount rate is zero. Suppose further that Genoma's managers are loyal agents of the existing shareholders. a) If the market expects Genoma's managers to issue equity and undertake the investment independent of the true value of the company, what is the fraction of the final value of the company that the managers have to promise to investors to convince them to invest $100M in the company?
b) If Genoma's managers know that the true value of Genoma's existing assets is 100M would they want to issue equity?
c) What if they know that the true value of Genoma's existing assets is $20M?
d) Suppose instead that the market expects that Genoma's managers will issue equity and undertake the investment only when they know that the true value of the company is $20M. What is the fraction of the final value of the company that the managers can promise to investors to convince them to invest $100M in the company?