Question

A venture capitalist, willing to invest $1,000,000, has three investments to choose from. The first investment, a software company, has a 10% chance of returning $5,000,000 profit, a 30% chance of returning $1,000,000 profit, and a 60% chance of losing the million dollars. The second company, a hardware company, has a 20% chance of returning $3,000,000 profit, a 40% chance of returning $1,000,000 profit, and a 40% chance of losing the million dollars. The third company, a biotech firm, has a 10% chance of returning $6,000,000 profit, a 65% of no profit or loss, and a 25% chance of losing the million dollars.

• Part (a)

  Construct a PDF for each investment.
  Software company:

  x	P(X = x)	x · P(X = x)
  $5,000,000
  $1,000,000
  −$1,000,000

  
  Hardware company:

  x	P(X = x)	x · P(X = x)
  $3,000,000
  $1,000,000
  −$1,000,000

  
  Biotech firm:

  x	P(X = x)	x · P(X = x)
  $6,000,000
  0
  −$1,000,000

• Part (b)

  Find the expected value for each investment.

  software company	$
  hardware company	$
  biotech firm	$

Part (c)

Which is the safest investment? Why do you think so?

• The second investment is safest because it has the greatest expected value.

• The third investment is safest because in the long run, the risk of losing any money is the least.   

• The first investment is safest because there is a 10% chance of making $5,000,000.

• The second investment is safest because there is a 60% chance of making money, which is higher than with the first and third investments.

Part (d)

Which is the riskiest investment? Why do you think so?

• The third investment is the riskiest because it has the greatest chance of not returning any money or losing money.

• The first investment is the riskiest because it has the greatest chance of losing money and the lowest expected value.    

• The third investment is the riskiest because it only has a 10% chance of returning any money.

• The second investment is the riskiest because there is a 40% chance of making $1,000,000 and a 40% chance of losing $1,000,000, so the result would be no change in the investment.

Part (e)

Which investment has the highest expected return, on average?

• software company

• hardware company    

• biotech firm

Answer 1