My friend Tim is trying to open up a new business and needs a great deal of investment money to get off the ground. The business is a zoo by day, nightclub by night, in downtown. Tim has no experience in this industry, and has never run or owned a business before. Although my financial advisor, friends and family say I shouldn’t, I invested $300,000 in Tim’s business, because he seems pretty confident it will make millions some day, and I will get 10% of his profits.
a) What is the calculated risk? this should be a dollar amount.
b)In what risk level would you categorize this investment and why?
a) To determine the calculated risk, you need to consider the potential loss associated with the investment. In this case, you invested $300,000 in Tim's business. So, the calculated risk would be $300,000.
b) This investment can be categorized as a high-risk investment. There are a few factors to consider for this categorization:
- Lack of experience: Tim has no experience in the industry and has never run or owned a business before. This increases the risk as he may face challenges in managing and operating the business effectively.
- Unique business model: Combining a zoo and a nightclub is an unconventional and relatively untested idea. It may be difficult to predict the success and profitability of such a venture, which further adds to the risk.
- Downtown location: The location of the business in downtown can be both advantageous and risky. While it may attract a large number of potential customers, it also comes with high competition and potentially high costs.
- Limited ownership stake: Although you will receive 10% of the profits, it is important to consider the potential return on investment. If the business does not generate significant profits, the returns for your $300,000 investment may be limited.
Considering these factors, the investment in Tim's business can be categorized as high-risk due to the lack of experience, unique business model, location, and limited ownership stake.