Question 2

Reviewing the past history of LIH applications, David estimated the probability that the application decision would be delayed beyond 60 days to be 20%. David then estimated that the probability that the outcome of the new proposal is favourable is 70%. Given that the outcome of the new proposal were favourable, David estimate that the probability of the LIH plan to be approved is 75%; if the outcome were unfavourable, the probability of approval is 30%. Finally, David estimated the probability that the property would still be available for purchase after the policy revision (if Real Estate took no action) to be 80%.

David next went to work on the financial analysis of the development project. The estimated profit of the new development project under the LIH plan would be $850,000. This value includes the purchase cost of the property, the cost of renovations, annual maintenance costs, annual rental incomes, and applicable tax shelters.

If LIH plan approval were not granted for the project, Real Estate would lose some of the attractive subsidies and tax shelters offered by SGHDA. On the other hand, if Real Estate develop non-subsidized commercial apartments instead (without LIH plan), the estimated profit would be $250,000.

You are expected to quantitatively evaluate the value of this project and give your recommendations. You may provide:

A decision tree analysis model for this problem;

Solve the optimal decision strategy and give your overall recommendation.