An investor is deciding whether to build a retail store. If she invests in the store and it is successful, she expects a return of $100,000 in the first year. If the store is not successful, she will suffer a loss of $80,000. She guesses that the probability that the store will be a success is 0.6.
To remove some of the uncertainty from this decision, the investor tries to establish more information, but this market research will cost $20,000. If she spends this money, she will have more confidence in her investment. There is a 0.6 probability that this information will be favorable; if it is, the likelihood that the store will be a success increases to 0.9. If the information is not favorable, the likelihood that the store will be a success reduces to only 0.2. Of course, she can elect to do nothing.
(a) What do you recommend?
(b) How much is the information worth? What is its efficiency?