A startup firm Northstar is considering building a hotel next to a new hockey arena in a city that is 1 of 3 vying for a new NHL franchise.

The NHL will announce which city will be awarded the franchise in one year, and that team will begin playing three years from today.

Because Northstar would like to be the official hotel of the NHL team, the property must be ready for guests when the first game is played in three years. It takes three years to build the hotel.

Projected Annual Cash Outflow to Build The Hotel Over 3-Years:

In 1-Year: Purchase Rights and Permits, Dig Hotel Foundation $1 million

In 2-Years: Construct building shell, attach electrical and plumbing $2 million

In 3-Years: Finish exterior and all interior $6 million

Projected Present Value from Operating the Hotel in Two Scenarios

Scenario #1: Good Case: The City Is Awarded The Franchise: $16 million

Scenario #2: Bad Case: The City Is Denied The Franchise: $4 million

For simplicity, lets assume that the discount rate is 0%. Also, assume that the firm have the option to quit after year 1. They can pay the city addition $1.0 million now to gain the right to terminate the project after year 1 if the city is not awarded the franchise.

With this option, what is the new tipping probability?