Unreal Networks, Inc., participated with several large music industry firms in a joint venture to distribute music electronically to third parties, such as Internet service providers and computer manufacturers, who would then sell the rights to download music to consumers. Unreal Networks is considering an investment in a start-up company that uses Unreal’s Internet-based audio and video technology to deliver music directly to consumers. However, the start-up company’s technology was unproven, and consumer enthusiasm for paying to download music was unclear. Unreal Networks has identified two investment options: (1) buy a controlling share of the start-up company now or (2) invest a smaller amount now both to support the technology and secure a relationship with the start-up with an option to buy the company later. If Unreal buys the start-up, it will terminate participation in the current joint venture.

Unreal’s analysts identified two major external events that could affect consumers’ willingness to pay for downloaded music. First, Apple Computer was beginning a service to sell downloaded music at $.99 per song. The success of that business could signal consumers’ willingness to pay for selected music. Second, music-recording companies were planning a legal strategy to discourage unlicensed music sharing and downloading. If successful, these approaches could enlarge the market for paid downloads.

Either of these events could improve the prospects for significant returns from a purchase of the start-up company; success of both would be a stronger signal.

Required

a. Draw decision trees that describe the investment options that Unreal Networks was considering.

Indicate the amounts that it must measure to complete the decision trees.

b. Describe the methods you would use to measure each of the amounts identified in requirement (a).

c. How would you recommend assessing the risks of the investment options?

d. What qualitative factors might be important to this decision?