SCO 3001 | Fall 2024 | Dr. Hailong Cui | Homework #4 (Decision Tree)
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[Q1: Decision Tree] Upon graduating, you decide to found a technology startup. You need to raise money
right now to build your company up as fast as possible! If all goes well, one year from today, your company
will be successful and will be acquired by Google. If Google acquires your company, you estimate that
they will pay $10 million dollars to be divided between you and your shareholders.
Although startup funding can be a complex topic, for this question we will simplify a lot. Let’s suppose
you have three options for raising money right now:
1. You go to Investor 1. Investor 1 is willing to give you $100K of funds right now in return for a 10%
equity share in your company. (This means that if you sell your company you have to give him 10%
of the profits, but if you go bankrupt, you don’t pay him anything.)
2. You go to Investor 2. Investor 2 is willing to give you $300K of funds right now in return for a 15%
equity share in your company. (Again, this means if you sell your company, you have to give her 15%
of the profits, but if you go bankrupt, you don’t pay her anything.)
3. You get a line of credit with a bank. The bank is willing to loan you $500K of funds right now, but you
must pay back the loan plus 3% interest in 1 year no matter what.
In addition, research tells you that startups that have more money early on are more likely to succeed in
the long-run. In particular,
1. if you have $100K of funds today, your ultimate probability of success in one year is 10%
2. if you have $300K of funds today, your ultimate probability of success in one year is 12%.
3. If you have $500K of funds today, your ultimate probability of success in one year is 15%
a) Draw a decision tree to help you decide which funding option you should choose.
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b) Assume that you are only interested in your expected earnings. Solve the tree to find the best funding
option. What is your optimal decision?