A particular company is considering bidding on a contract for a new office building complex. The figure below shows the decision tree prepared by one of the company's analysts. At node 1, the company must decide whether to bid on the contract. The cost of preparing the bid is $240,000. The upper branch from node 2 shows that the company has a 0.8 probability of winning the contract if it submits a bid. If the company wins the bid, it will have to pay $2,000,000 to become a partner in the project. Node 3 shows that the company will then consider doing a market research study to forecast demand for the office units prior to beginning construction. The cost of this study is $160,000. Node 4 is a chance node showing the possible outcomes of the market research study. Nodes 5, 6, and 7 are similar in that they are the decision nodes for the company to either build the office complex or sell the rights in the project to another developer. The decision to build the complex will result in an income of $5,000,000 if demand is high and $3,000,000 if demand is moderate. If the company chooses to sell its rights in the project to another developer, income from the sale is estimated to be $3,500,000. The probabilities shown at nodes 4, 8, and 9 are based on the projected outcomes of the market research study.

Bid

Do Not Bid

1

2

3

4

5

6

7

8

9

10

Win Contract .8

Lose Contract .2

Market Research

No Market Research

Forecast High .6

Forecast Moderate .4

Build Complex

Sell

Build Complex

Sell

Build Complex

Sell

High Demand .85

High Demand .225

High Demand .6

Moderate Demand .15

Moderate Demand .775

Moderate Demand .4

2,600

600

1,100

2,600

600

1,100

2,760

760

1,260

240

0

Profit ($ 1,000s)

An image of a decision tree is shown. Some of the branches eventually terminate at various values in a column labeled "Profit ($ 1,000s)" on the right side of the image.

• The decision tree begins at decision node 1 and an upper and lower branch extend from this node to the right. The upper branch, labeled "Bid," stops at chance node 2 and an upper and lower branch extend from this node to the right. The lower branch, labeled "Do Not Bid," extends all the way to the right and ends at a value of 0.
• The upper branch extending from chance node 2, labeled "Win Contract, .8," stops at decision node 3 and an upper and lower branch extend from this node to the right. The lower branch, labeled "Lose Contract, .2," extends all the way to the right and ends at a value of 240.
• The upper branch extending from decision node 3, labeled "Market Research," stops at chance node 4 and an upper and lower branch extend from this node to the right. The lower branch, labeled "No Market Research," stops at decision node 7 and an upper and lower branch extend from this node to the right.
• The upper branch extending from chance node 4, labeled "Forecast High, .6," stops at decision node 5 and an upper and lower branch extend from this node to the right. The lower branch, labeled "Forecast Moderate, .4," stops at decision node 6 and an upper and lower branch extend from this node to the right.
• The upper branches extending from decision nodes 5, 6, and 7, each labeled "Build Complex," stops at chance nodes 8, 9, and 10, respectively, and an upper and lower branch extend from each of these nodes to the right. The lower branches extending from decision nodes 5, 6, and 7, each labeled "Sell," extend all the way to the right and end at a values of 1,100, 1,100, and 1,260, respectively.
• The upper branch extending from chance node 8, labeled "High Demand, .85," ends at a value of 2,600 and the lower branch, labeled "Moderate Demand, .15," ends at a value of 600. The upper branch extending from chance node 9, labeled "High Demand, .225," ends at a value of 2,600 and the lower branch, labeled "Moderate Demand, .775," ends at a value of 600. The upper branch extending from chance node 10, labeled "High Demand, .6," ends at a value of 2,760 and the lower branch, labeled "Moderate Demand, .4," ends at a value of 760.

(a)

Verify the company's profit projections shown at the ending branches of the decision tree by calculating the payoffs of $2,600,000 and $600,000 for first two outcomes, the outcomes extending from chance node 8.

Outcome 1	($ in 1,000s)
Bid
Contract
Market research
High demand
Total	$2,600

Outcome 2	($ in 1,000s)
Bid
Contract
Market research
Moderate demand
Total	$600

(b)

What is the optimal decision strategy for the company?

Bid on the contract. Do the market research. If the forecast is high, sell the rights in the project to another developer. If the forecast is moderate, build the complex.Bid on the contract. Do not do the market research. Build the complex. Bid on the contract. Do not do the market research. Sell the rights in the project to another developer.Bid on the contract. Do the market research. If the forecast is high, build the complex. If the forecast is moderate, sell the rights in the project to another developer.Do not bid on the contract.

What is the expected profit (in $) for this project?

$

(c)

What would the cost (in $) of the market research study have to be before the company would change its decision about conducting the study?

$