Yilin (Leon) Chen

Investor Information

You are an investment manager with a specialization in the energy sector from a venture capital firm. For this time period, there are many entrepreneurs who have opportunities to develop an oil field in a large region that is recently discovered to contain oil. For the purpose of simplicity, all entrepreneurs have the same information below.

 

Each entrepreneur has already invested in land that is worth $100,000. Each has no additional funding and needs to seek your 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, the entrepreneur can sell the land and all equipment for a total price of $120,000. For simplicity, in each deal with an entrepreneur you can invest EITHER debt or equity, but not both (you can certainly use debt in one deal, and equity in another). 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 a 50% chance of success.

 

  Success (1) Failure (2) Expected Payoff (assuming 50% chance of success)
Debt payoff $100,000 ×

(1 + negotiated interest rate)

$100,000 × (1 + negotiated interest rate), or $120,000, whichever is lower    50% × (1)

+ 50% × (2)

Equity payoff Your negotiated % of ownership × $480,000 Your negotiated % of ownership × $120,000    50% × (1)

+ 50% × (2)

 

Your GOAL:

MAXIMIZE YOUR ACTUAL PROFIT through all rounds. You will achieve this through negotiating financing deals with different entrepreneurs, i.e., through negotiating either an interest rate if the debt is used, or a % of ownership if equity is used. A worksheet is attached for your convenience to help to record deal details and calculating profits or losses.

 

RULES:

  1. 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.
  2. During Period I, all entrepreneurs will have 50% as the chance of success.
  3. During Period II, each entrepreneur will have a different assigned probability of success, and each needs to truthfully reveal that probability information to you.
  4. During Period III, each entrepreneur will also have a different assigned probability of success, but you, as an investor, do NOT know that information (i.e., entrepreneurs do NOT need to reveal that probability information to you). But what you know is that the average chance of success for the whole group of entrepreneurs is close to 50%, with a possible range between 30% and 80%.
  5. You MUST report the transaction details to the instructor whenever a round is finished.
  6. You can make a maximum number of 3 deals in each round with different (not the same) entrepreneurs, through negotiations with the entrepreneurs, but you are NOT required to make any deals in each round.

 

 

Investor Worksheet

 

PERIOD I: 50% chance of success for each entrepreneur

 

 

Round

Chance of success Which entrepreneur 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 entrepreneur 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

             
             
             
 

4

             
             
             

 

PERIOD III: different and UNKNOWN chance of success for each (50% on average)

 

 

Round

Chance of success Which entrepreneur 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

             
             
             
 

6

             
             
             
 

7

             
             
             

 

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