Stochastic Dominance Partners (SDP) was a venture capital firm that raised $100M from a local pension fund called LPF. The terms SDP received from LPF specified that after ten

years, SDP had to pay back LPs investment, plus a non-cumulative dividend of 8% per year. Any additional value would be shared with 80% going to LPF and 20% going to SDP. SDP received a total of $15M in management fees over the life of the fund. After 9 years, SDP had invested $75M in a variety of companies that had returned a total of $150M. The fund had $10M left and considered making one final investment. It faced two options.

1. The first investment option was to place $10M in Certainty Sludge Solutions (CSS), a waste management company that was considered very safe. It was guaranteed to double in value within a year, at which time SDP would be able to sell its stake.

2. The second investment option was to place $10M in Roller Coast Tidal (RCT) a highly speculative tidal wave energy investment that within a year would be worthless with 80% probability, but with 20% probability it would be worth $45M.

2.1 If SDP wanted to maximize its own profits, which of those two investments should it choose, and why? Make sure to calculate SDPs profits under each investment option, taking into account the terms with LPF. (1 point)

2.2. How would your answer change if instead of having a 20% chance of success, RCT had a 50% chance of success? (1 point)

2.3. How would your answer change if instead of receiving a 20% profit share, SDP would receive a 30% profit share? (1 point)

2.4. How would your answer change if instead of having a return of $150M, SDP had accumulated a return of $250M by year 9? (1 point)

2.5. Describe the reasons and implications for your answers to parts 2-4. What explains these results? (1 point)

2.6. What implications does this have for risk-taking incentives in venture capital? Is this a good or a bad thing? (1 point)