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Starting Right

Corporation

Topic Outline
Facts of the Case
Discussion Questions

Facts of the Case


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

who
own
she
new

Facts of the Case


Julia 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 Case


Julia 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 Case


Three options were considered:
1. corporate bonds;
2. preferred stock; and
3. common stock.

Facts of the Case


Each 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 Case


Corporate 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 Case


Investors 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 Questions
This is a decision-making-under-uncertainty case.
There are two events: a favorable market and an
unfavorable market.
There are four alternatives:
1. invest in corporate bonds;
2. invest in preferred stock;
3. invest in common stock; and,
4. do nothing.

Discussion Questions
Using 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 Questions
The decision table is presented below.
Favorable
Market ($)

Unfavorable
Market ($)

Corporate Bonds

55,273.06

10,000

Preferred Stock

120,000

15,000

Common Stock

240,000

30,000

Do Nothing

Discussion Questions
a. 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.
Favorable
Market ($)
Corporate
Bonds
Preferred Stock
Common Stock
Do Nothing

Maximin
($)

55,273.06

Unfavorabl
e
Market ($)
10,000

120,000
240,000
0

15,000
30,000
0

15,000
30,000
0

10,000

Discussion Questions
b. Ray Cahn should use a success probability of 0.11.
The best decision is to do nothing.
Favorable
Market ($)
Corporate
Bonds
Preferred Stock

55,273.06

Unfavorabl
e
Market ($)
10,000

Hurwicz
Value
($)
2,819.96

120,000

15,000

150.00

Common Stock

240,000

30,000

300.00

Do Nothing

Discussion Questions
c. 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.
Favorable
Market

Corporate
Bonds
Preferred
Stock
Common
Stock

Unfavorab
le
Market
55,273.06
10,000

Maximin
($)
10,000

120,000

15,000

15,000

240,000

30,000

30,000

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

Corporate
Bonds
Preferred
Stock
Common
Stock
Do Nothing

Unfavorabl
Equally
e
likely
Market
55,273.06
10,000
22,636.53
120,000

15,000

52,500

240,000

30,000

105,000

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

Corporate
Bonds
Preferred
Stock
Common
Stock
Do Nothing

Favorable Unfavorab Maximax


Market
le
Market
55,273.06 10,000 55,273.06
120,000

15,000

120,000

240,000

30,000

240,000

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