18

Part II: End-of-Chapter Questions

BD Chapter 12: Problem 9; Problem 13; Problem 14; Problem 15; Problem 21

BD Chapter 15: Problem 2; Problem 5; Problem 10; Problem 11

Part III: Additional Essay Questions

1.

This problem provides an example of real opti

ons. One advantage of using staged financing

in the venture capital industry is that the vent

ure capitalists (VCs) do not have to provide all

of their capital to the firms they fund at once and can have the option not to provide further

funding as more information becomes available. Consider a young start-up company that

needs $200 million from a VC to fund a project. Both the firm and the VC will receive further

information about the viability/profitability of the project only in one year (after the project

has been tested). If the news is

good after the above testing period (1 year), they know that

the project will succeed in another 5 years fro

m then and return $400 million dollars. If the

news is bad after the testing period (1 year),

they know that the project will fail in another 5

years from then and return only $10 million. Th

e cost of capital is 10%. The probability of

having good news in one year is 50%.

(i)

If the VC does not have the option of staging its financing and has to provide all the

needed capital ($200 million) today, should

it go ahead and invest? Why or why not?

(ii)

Now assume that the VC has the option of stag

ing its investment: it only has to invest

half of the total amount ($100 million) today a

nd can decide whether to provide the rest

of funding ($100 million) in one year, depending

on whether the news is good or bad. In

this scenario, should the VC go ahead and invest in the company (i.e., provide the first

round of financing of $100 m

illion)? Why or why not?