You work for zoom capital, a venture capital firm, and are considering m o underperforming firms each of o different industries (Pharmaceuticals and Financial Services). You will only buy into one of the firms and hoping to make a big return after the firm you help tenders an initial public offering in 2 years. You are going to finny invest $100,000,000.
If you leave the money in your current portfolio, you will earn a return of $34,000,000 across those two years.
Since you are in the financial services industry, you have a deep understanding of the environment in which the two potential firms are operation.
Rewards-R-Us is a credit card rewards Management Company that offers systems to credit and debit card issuers to manage their credit card rewards programs. Your $100,000,000 investment will grow their systems to handle the world's largest card issuers. If consumer confidence stays high you expect to earn a $50,000,000 return. If consumer confidence falls to low you expect to earn a $10,000,000 return.
Loan-2-Day is a short-term loan agency that grants signature 30-day loans against a paystub. Your $100,000,000 will allow them to open branches outside of manufacturing centers across the United States. If consumer confidence stays high you expect to earn a $30,000,000 return. If consumer confidence falls to low you expect to earn a $60,000,000 return.
Your experience in the Pharmaceutical Industry is weak.
BrightDay is working on a non-addictive over-the-counter caffeine substitute that they claim has a mood uplifting effect as well as increasing alertness. Your $100,000,000 will allow them to engage in the final human testing phase of FDA approval. If they win approval you expect a $ 100,000,000 return. If they fail you will lose $50,000,000.
PhytoLife is working on an over-the-counter life extension product that will add 20 years to the average person's life expectancy. Your $100,000,000 will allow them to engage in the final human testing phase of FDA approval. If they win approval you expect a $120,000,000 return. If they fail, you will lose $60,000,000.
a. Construct the decision tree for choosing which investment opportunity to choose. You know that 60% of companies at this stage win FDA approval. You know that consumer confidence will be high with a 90% probability. Solve the decision tree with expected values. What investment opportunity do you choose?
b. If you commissioned a feasibility study into the FDA approval process of the two companies of interest, the feasibility study could come back positive or negative. If positive, BrightDay has a 90% chance of approval and PhytoLife has a 75% chance of approval. If the result is negative then BrightDay has 50% chance of approval and PhytoLife has a 40°, 6 chance of approval. The study has a 60% chance of coming back positive. Draw the new decision tree.
c. What is the most you would be willing to pay for the study?