Appendix II: Handout to entrepreneur groups for Investor-Entrepreneur Simulation
Yilin (Leon) Chen
Entrepreneur Information
You are an entrepreneur who has an opportunity to develop an oil field in a large region that is recently discovered to contain oil. You have already invested in the land that is worth $100,000. You have no additional funding and need to seek investment to finance a rig that costs $100,000. The average chance of success of a potential oil field is 50%, in which case the oil field will be worth $480,000. If the business fails, you can sell the land and all equipment for a total price of $120,000. In order to finance a rig, you will need to negotiate a deal with an investor of your choice. If you do not have a deal, you can still sell the land for $100,000 (same as your original investment) and your profit will be zero.
Also, in this fictitious game, there are other entrepreneurs who are facing exactly the same situation as described above. For simplicity, in negotiating a deal with an investor, you can finance the rig using EITHER debt or equity, but not both (you can certainly use debt in one deal, and equity in another in multiple rounds). Also, assume that this is a 1-year investment. For your convenience, the table below summarizes your payoff scenarios at the end of the investment time period, with the assumption of 50% chance of success.
| Success (1) | Failure (2) | Expected Payoff (assuming 50% chance of success) | |
| Payoff if using debt | $480,000 – $100,000 ×
(1 + negotiated interest rate) |
$120,000 – $100,000 × (1 + negotiated interest rate), or $0, whichever is higher | 50% × (1)
+ 50% × (2) |
| Payoff if using equity | (1 – % of ownership sold) × $480,000 | (1 – % of ownership sold) × $120,000 | 50% × (1)
+ 50% × (2) |
Your GOAL:
MAXIMIZE YOUR ACTUAL PROFIT though all rounds. You will achieve this through negotiating a financing deal with different investors in each round, i.e., through negotiating either an interest rate if debt is used, or a % of ownership if equity is used. A worksheet is attached for your convenience to help recording deal details and calculating profits or losses.
RULES:
- The game has three periods, and multiple rounds in each period. The instructor will announce when each round starts and ends, and will also announce whether each oil field is success or failure after each round, using a result drawing with the given probability.
- During Period I, all entrepreneurs will have 50% as the chance of success.
- During Period II, you will have an assigned probability of success, and you need to truthfully reveal that probability information to the investor. The average chance of success for all entrepreneurs in this period is close to 50%.
- During Period III, you will have an assigned probability of success, but you do NOT need to reveal that probability information to any investor. The average chance is still close to 50%.
- You can make a maximum number of one deal in each round, through negotiating with any investor of your choice, but you are NOT required to make any deals in each round. If you do not make a deal, your profit will be zero in that round.
Entrepreneur Worksheet
PERIOD I: 50% chance of success for each entrepreneur
|
Round |
Chance of success | Which investor | Negotiated debt interest rate (only if debt is used) | Negotiated % of investor ownership (only if equity is used) | Expected Profit
(= expected payoff – $100,000) |
Actual Profit (= payoff under either success or failure – $100,000) |
Cumulative Profits |
|
1 |
50%
|
||||||
|
2 |
50% |
PERIOD II: different but KNOWN chance of success for each (50% on average)
|
Round |
Chance of success | Which investor | Negotiated debt interest rate (only if debt is used) | Negotiated % of investor ownership (only if equity is used) | Expected Profit
(= expected payoff – $100,000) |
Actual Profit (= payoff under either success or failure – $100,000) |
Cumulative Profits |
|
3 |
40% |
||||||
|
4 |
60% |
PERIOD III: different and UNKNOWN chance of success for each (50% on average)
|
Round |
Chance of success | Which investor | Negotiated debt interest rate (only if debt is used) | Negotiated % of investor ownership (only if equity is used) | Expected Profit
(= expected payoff – $100,000) |
Actual Profit (= payoff under either success or failure – $100,000) |
Cumulative Profits |
|
5 |
70% |
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|
6 |
50% |
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|
7 |
30% |
