Starting Right Corporation

Topic OutlineFacts of the CaseDiscussion Questions

Facts of the CaseAfter watching a movie about a young woman who quit a successful corporate career to start her own baby food company, Julia Day decided that she wanted to do the same.Julia resigned from her job and launched her new company Starting Right.

Facts of the CaseJulia decided to target the upper end of the baby food market and wanted to produce baby food that contained no preservatives but had a great taste.Instead of putting the baby food in jars, Julia decided to try a new approach the baby food would be frozen.

Facts of the CaseJulia decided to find people with experience in finance, marketing, and production to get involved in Starting Right.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 was a hit.The final key to getting the young company off to a good start was to raise funds.

Facts of the CaseThree options were considered: corporate bonds;preferred stock; andcommon stock.

Facts of the CaseEach investment should be in blocks of $30,000.Each investor should have an annual income of at least $40,000 and a net worth of $100,000.

Facts of the CaseCorporate bonds would return 13% per year for the next five years.Julia 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.

Facts of the CaseInvestors in common stock 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 five years, it was expected that inflation would increase by a factor of 4.5% each year.

Discussion QuestionsThis is a decision-making-under-uncertainty case.There are two events: a favorable market and an unfavorable market. There are four alternatives: invest in corporate bonds;invest in preferred stock;invest in common stock; and,do nothing.

Discussion QuestionsUsing the future value of a dollar [present value x (1+interest rate)^number of years], the return in a good market for corporate bonds in five years is [30,000(1+0.13)5] = $55,273.06. The return in a good market for preferred stock is (4 x $30,000) = $120,000 and for common stock is (8 x $30,000) = $240,000.

Discussion QuestionsThe decision table is presented below.

FavorableMarket ($)UnfavorableMarket ($)Corporate Bonds55,273.0610,000Preferred Stock120,00015,000Common Stock240,00030,000Do Nothing00

Discussion Questionsa. Sue Pansky is a risk avoider and should use the maximin decision approach. She should do nothing and not make an investment in Starting Right.

FavorableMarket ($)UnfavorableMarket ($)Maximin ($)Corporate Bonds55,273.0610,00010,000Preferred Stock120,00015,00015,000Common Stock240,00030,00030,000Do Nothing000

Discussion Questionsb. Ray Cahn should use a success probability of 0.11. The best decision is to do nothing.

FavorableMarket ($)UnfavorableMarket ($)Hurwicz Value($)Corporate Bonds55,273.0610,0002,819.96Preferred Stock120,00015,000150.00Common Stock240,00030,000300.00Do Nothing000

Discussion Questionsc. Since Lila Battle will invest in the company, she will eliminate doing nothing, and apply the maximin criterion. The result is to invest in corporate bonds.

FavorableMarketUnfavorableMarketMaximin($)Corporate Bonds55,273.0610,00010,000Preferred Stock120,00015,00015,000Common Stock240,00030,00030,000

Discussion Questionsd. George Yates should use the equally likely decision criterion. The best decision for George is to invest in common stock.

FavorableMarketUnfavorableMarketEqually likelyCorporate Bonds55,273.0610,00022,636.53Preferred Stock120,00015,00052,500Common Stock240,00030,000105,000Do Nothing000

Discussion Questionse. Pete Metarko is a risk seeker. He should invest in common stock.

FavorableMarketUnfavorableMarketMaximaxCorporate Bonds55,273.0610,00055,273.06Preferred Stock120,00015,000120,000Common Stock240,00030,000240,000Do Nothing000

Discussion Questionsf. Julia Day can eliminate the preferred stock alternative and still offer alternatives to risk seekers (common stock) and risk avoiders (investing in corporate bonds).