5. (18 marks) A company wanting to build a hotel in downtown St....

5. (18 marks) A company wanting to build a hotel in downtown St. John's needs to buy

two adjacent properties. The appraised values for Properties 1 and 2 are $1,000,000,

and $2,600,000 respectively. They can try to buy these properties (by making separate

offers to the two owners) for 50% more than the appraised value, for which

there is a 75% chance that the owner of Property 1 would agree to sell, and an 80%

chance that the owner of Property 2 would agree to sell. If an offer at 1.5 times appraised

value is turned down, they could then offer double the appraised value for

that property, for which it is certain that the owner (of either property) would agree

to sell. Ending up with no properties is worth nothing; ending up with just one

property is worth only the appraised value of that one property; ending up owning

both is worth $6,000,000.

(a) Given that at the outset any offer to buy would be made to both owners simultaneously,

draw a decision tree to determine what the hotel developer should do.

(Hint: You might find it easier to imbed all costs at the end.)

(b) Determine the EVPI by any method.