Chapter $3$ Decision Analysis

Getting good people to work for the new company was also important. Julia decided to find people with experience in finance, marketing, and production to get involved with Starting Right. With her enthusiasm and charisma, Julia was able to find such a group. Their first step was to develop prototypes of the new frozen baby food and to perform a small pilot test of the new product. The pilot test received rave reviews.

The final key to getting the young company off to a good start was to raise funds. Three options were considered: corporate bonds, preferred stock, and common stock. Julia decided that each investment should be in blocks of $$30,000.$ Furthermore, each investor should have an annual income of at least $$40,000$ and a net worth of $$100,000$ to be eligible to invest in Starting Right. Corporate bonds would return $13\%$ per year for the next $5$ years. Julia furthermore guaranteed that investors in the corporate bonds would get at least $$20,000$ back at the end of $5$ years. Investors in preferred stock should see their initial investment increase by a factor of $4$ with a good market or see the investment worth only half of the initial investment with an unfavorable market. The common stock had the greatest potential. The initial investment was expected to increase by a factor of $8$ with a good market, but investors would lose everything if the market was unfavorable. During the next $5$ years, it was expected that inflation would increase by a factor of $4\mathrm{.}5\%$ each year.

Discussion Question

Sue Pansky, a retired elementary school teacher, is considering investing in Starting Right. She is very conservative and is a risk avoider. What do you recommend?

Ray Cahn, who is currently a commodities broker, is also considering an investment, although he believes that there is only an $11\%$ chance of success. What do you recommend?

Lila Battle has decided to invest in Starting Right. While she believes that Julia has a good chance of being successful, Lila is a risk avoider and very conservative. What is your advice to Lila?

George Yates believes that there is an equally likely chance for success or failure. What is your recommendation?

Peter Metarko is extremely optimistic about the market for the new baby food. What is your advice for Pete?

Julia Day has been told that developing the legal documents for each fund$-$raising alternative is expensive. Julia would like to offer alternatives for both risk$-$averse and risk$-$seeking investors.

Can Julia delete one of the financial alternatives and still offer investment choices for risk seekers and risk avoiders?