Question

After watching a movie about a young woman who quit a successful corporate career to start her own baby food com- pany, Julia Day decided that she wanted to do the same. In the movie, the baby food company was very successful. Julia knew, however, that it is much easier to make a movie about a successful woman starting her own company than to actu- ally do it. The product had to be of the highest quality, and Julia had to get the best people involved to launch the new company. Julia resigned from her job and launched her new company—Starting Right.

Julia decided to target the upper end of the baby food mar- ket by producing baby food that contained no preservatives but had a great taste. Although the price would be slightly higher than for existing baby food, Julia believed that parents would be willing to pay more for a high-quality baby food. Instead of put- ting baby food in jars, which would require preservatives to sta- bilize the food, Julia decided to try a new approach. The baby food would be frozen. This would allow for natural ingredients, no preservatives, and outstanding nutrition.

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: corpo- rate bonds, preferred stock, and common stock. Julia decided that each investment should be in blocks of $30,000. Further- more, 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 he next five years. Julia furthermore guaranteed that investors in the corporate bonds would get at least $20,000 back at the end of five 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 great- est potential. The initial investment was expected to increase by a factor of 8 with a good market, but investors would lose every- thing if the market was unfavorable. During the next five years, it was expected that inflation would increase by a factor of 4.5% each year.

Discussion Questions

1. Sue Pansky, a retired elementary school teacher, is con- sidering investing in Starting Right. She is very conserva- tive and is a risk avoider. What do you recommend?

2. 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?

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

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

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

6. Julia Day has been told that developing the legal docu- ments for each fundraising alternative is expensive. Julia would like to offer alternatives for both risk-averse and risk-seeking investors. Can Julia delete one of the finan- cial alternatives and still offer investment choices for risk seekers and risk avoiders?

Answer 1

Solution

1.Given that Sue Pansky is a very conservative and is a risk avoider.So,i would suggest that she should avoid her decsion to invest in Starting Right since there is a 50 % probability that her $30,000 investment would become $20,000 at the end of 5 years if she opts for Corporate Bonds.

But in case she wants to invest anyways then she should opt for the corporate bonds since this is having the least risk among all the available investment options

2.Ray Cahn should opt for investment in the stocks since the return is high as well as the risk associated is also the highest among the available investment options.He being a Commodities Broker shows that he is a risk taking,aggressive investor (he believes investing inspite of his perception of 11% success rate).

3.Since  Lila Battle is also a risk avoider and conservative she should opt for Corporate Bonds.

4.George Yates should opt for Preferred Shares option as it aggressive when compared to the corporate bonds option but less agressive than stocks.Since he believes in equal chances of success of his investments.

5.Sice Peter is extremely optimistic he should opt for Common Stock option since it has the maximum return of 8 times.

6.Yes she can remove the option for Preferred StockThen all the risk averse investors will opt for Corporate Bonds and the Risk seeking ones will opt for the Commpon Stock

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