A large development firm is considering bidding on a contract for a new office building complex. Figure 19.9 shows the decision tree prepared by one of their analysts. At node I, the firm must decide whether to bid on the contract. The cost of preparing the bid is $200,000. The upper branch from node 2 shows that the firm has a .8 probability of winning the contract if it submits a bid. If the firm wins the bid, it will have to pay $2,000,000 to become a partner in the project.

Node 3 shows that the firm 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 $150,000. Node 4 is a chance node showing the possible outcomes of the market research study. Nodes 5, 6, and7 are similar in that they are the decision nodes 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 they choose 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.

 

Profit ($1000) High Demand 85 2650 Build Complex Moderate Demand Forecast High 650 15 Sell 1150 Market Research High Demand 225 2650 Build Complex Forecast Moderate Moderate Demand 650 .775 Win Contract Sell 1150 High Demand 2800 Build Complex Bid No Market Resewch Moderate Demand 800 Sell 1300 Lose Contract -200 Do Not Bid Scenario #1: Part A What is the optimal decision strategy based on the expected value decision criterion? Scenario #1: Part B What is the expected profit or loss for this project? Scenario #1: Part C What would the cost of the market research have to be before the firm would change its decision about the market research study?