Problem Set #1
1. Software Marketing
You have developed a popular piece of business software that runs on the Windows platform.
You recognize that the Linux platform is growing in popularity and have developed a version of
the program to run on Linux. That development cost you $2 million, money that you have
already spent. To sell the Linux version, however, you also must do a marketing campaign,
which will cost $1 million. You aren't sure, however, whether Linux will be successful as a
platform for business users. If it is, you will sell a lot of copies of your program for Linux (for a
profit of $6m after production and distribution expenses, not counting development or
marketing). If not, you will sell very few copies (for a profit of $500,000 after production and
distribution expenses, not counting development or marketing). You estimate the probability of
Linux succeeding at 0.7.
a. A consultant says that she can do a study of the market and tell you with certainty whether or
not Linux will succeed as a business platform. She can do this study before you make your
investment in marketing the software for Linux. How much is it worth to you to know whether
Linux will succeed before you have to make the marketing decision?
2. VC Decision Tree
You are raising $10 million for a new venture. You know that you can borrow the money from
your rich uncle, but then you would have to put up with him looking over your shoulder all the
time. It is worth $50,000 to you to get the financing from a venture capitalist instead (same
terms as you would get from the rich uncle). You have appointments with two VCs. The first
appointment is with a VC known for giving people only 5 minutes for their pitch. The second
VC gives people up to an hour. To prepare for the first meeting, you need to spend about
$10,000 in preparation costs. There is no point in preparing more since you only get 5 minutes.
There is value in preparing more for the second VC since you may get up to an hour with her.
But if the first VC funds you, you will cancel you appointment with the second. Light
preparation (the amount you would do for the first VC) costs $10,000. Heavy preparation costs
an extra $20,000, raising the total preparation cost to $30,000. The additional preparation has no
effect on your chances of getting funding from the first VC (who has a 0.3 probability of funding
you so long as you do light preparation), but it raises the probability of the second VC funding
you from 0.2 (with just light preparation) to 0.7 (with heavy preparation).
Unfortunately, your appointments with the two VCs are on the same day, so you would not have