Decision Analysis Assignment

Property Purchase

BSTA 320

Bruce James, president of Watts Development, is considering submitting a bid to purchase property that will be sold by a sealed bid at a municipal tax foreclosure. Bruces initial judgement is to submit a bid of $5 million. From past experience Bruce estimates that a bid of $5 M will have a 40% chance of being the highest bid and securing the property for Watts Development. Sealed bids must be submitted by November 1 with the winning bid being announced November 15.

Another option for Bruce is to invest in Lakeside View, a condominium development already in progress. He would be sharing revenues with another developer, and would be guaranteed a return of $1M.

If Bruce bids on the property and wins and obtains the property, the firm will need to decide to build and sell either luxury condominiums or standard condominiums. However, the property is currently zoned for single family residences. Bruce believes that the firm could go to municipal council and ask for an amendment to the zoning bylaw that would permit the building of condominiums. The probability of a zoning bylaw change Bruce estimates at 0.3. If the zoning bylaw changes to permit condominium development Bruce realizes that two states of nature are possible: the condominiums will be in high demand (.6) or low demand (.4). Payoffs for each state of nature for each decision are given in the table below.

The sealed bid procedure requires that the bid be submitted along with a certified cheque for 20% of the amount bid. If the bid is rejected the deposit is refunded and Bruce could still decide to invest in the Lakeside View development with a guaranteed return of $1M. If the bid is accepted the deposit is the down payment for the property and the winner would have four months to come up with rest of the purchase price. Failing to do so would mean that the deposit is lost and the property would go to the next highest bidder.

Watts Development is not interested in building single family residences and would not proceed with this type of development if the zoning law is not amended. Unfortunately, the application process for a zoning change could take about six months. Consequently, if the zoning bylaw is not changed Bruce would lose the deposit. He could still invest in the Lakeside View development, but due to the 6 month delay would not be guaranteed $1M in return. Although a $1 M may still be possible Bruce estimates that the probability for such a return would be only 0.25 while a $700 000 return on the Lakeside development more likely, at a probability of 0.75.

In order to decide whether or not to bid the $5 M, Bruce gathered estimates of costs and revenues for the projected developments if the bid is approved and if the zoning bylaw is changed to permit condominium development.

Condominium Type	Cost	Revenue
	Property	Construction Expense	High Demand	Low Demand
Luxury	$5M	$12 M	$23 M	$17 M
Standard	$5M	$8 M	$17M	$15 M

Bruce is concerned about the zoning amendment approval and its significance to the expected profits of this decision. He is considering hiring Ben-Luke Consultants who will study recent zoning amendment applications. The consulting firms fee is $50 000 and the report will either indicate that the zoning amendment will be approved or not approved. Bruce notes that the past record of Ben-Luke Consulting reveals that in similar cases, the probability that Ben-Luke predicted zoning amendment approval given that it was approved was 0.7 and the probability of predicting that the zoning amendment would not be approved given that zoning amendment was not approved was 0.8. The probability of high demand or low demand remains the same whether or not Ben-Luke predicts approval or disapproval of the zoning amendment.

Managerial Report

a) Give a brief description of the decision problem facing Bruce and Watts Development. (1 mark)

b) Draw the decision tree and perform a decision tree analysis of Bruces decision situation without the consultants information. According to the EMV criteria what is the strategy Bruce should take? What is the EMV of this strategy? (6 marks)

c) Using the consultants information construct a revised decision tree and perform an analysis of the decision. Be sure to show calculations of posterior probabilities. What is the EMV decision strategy that Bruce should follow and the expected value of this decision? (9 marks)

d) What is the value of the information provided by Ben-Luke Consultants (EVSI)? Should Bruce hire Ben-Luke Consultants? Why? (3 marks)

e) Comment on the use of decision analysis in this case. (1 mark)