Please provide answers to the following questionAndy and Kim live together. Andy may invest $10,000 (possibly by taking on an extra job to earn the additional money) in Kim’s MBA education this year. This investment will raise the current value of Kim’s earnings by $24,000. If they stay together, they will share the benefit from the additional earnings. However,the probability is 12 that they will split up in the future. If they were married and then split, Andy would get half of Kim’s additional earnings. If they were living together without any legal ties and they split, then Andy would get nothing. Suppose that Andy is risk-neutral. Will Andy invest in Kim’s education? Doesyour answer depend on the couple’s legal status?During the Great Recession, many homeowners around the world owed more on their houses than they were worth. Often, U.S. borrowers who cannot meet their mortgage payments can give their houses to the banks that hold their mortgage without declaring bankruptcy or being held accountable for any unpaid balance. However, Europeans, who face tougher bankruptcy laws, are responsible for unpaid mortgage balances even after losing their homes (Gabriele Steinhauser and Matthew Dalton, “Lingering Bad Debts Stifle Europe Recovery,” Wall Street Journal, January 31, 2013). Using a decision tree, show that Americans are more likely to buy houses than Europeans, all else the same.A risk-neutral firm believes that the probability of a harmful cyberattack (see the Mini-Case “Risk of a Cyberattack”) is 25%. It expects to make a profit of $200 million if no attack occurs and $120 million if it is attacked. The firm can spend $5 million to increase its electronic defenses, which reduces the probabilityof a successful cyberattack to 10%. Use a decision tree similar to Figure 14.4 to assess whether the firm should make this investment.R&D investments are a major source of business uncertainty. Do all risk-averse managers fail to invest in R&D? Why or why not?
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