You manage the finances of a company looking for new investments to grow its portfolio. A small business owner approaches you with and opportunity: invest in his company and you have a 50% chance of seeing a return of $10,000 three years from now. Of course there is also a 50% chance that the small business fails and you see no return.
a. Assuming the interest rate is 4% and your company is risk-neutral (i.e. all it cares about is the expected value of the investment), what is the maximum of amount of your company’s money you are willing to give up today for the investment? Now your company is thinking about how best it can raise several million dollars to expand its capacity. No single bank is willing to loan your company that much money all at once. Your boss asks for your advice.
b. What other options does a company have to raise a large sum of money in a short period of time?
c. What are the advantages and disadvantages of each type of financing?
d. Which type of financing would you suggest for your company? Why?