What is the Anchoring bias? How might is play a role in the decision in SLP 2/SLP 3? In what way might this bias cause error in the estimation of the probabilities? How could you mitigate the effect of this bias?

RISK: FREQUENCY DISTRIBUTION, PROBABILITIES, AND EXPECTED VALUE Scenario: You are an entrepreneur that has several business investments in real estate, restaurants, and retail stores. You are looking for your next investment opportunity for you and your private equity investment company. You have found two possible alternatives to invest in that will payoff in the next 10 years. Here are the descriptions of the two options. Option A: Real estate development. This is a risky opportunity with the possibility of a high payoff, but also with no payoff at all. You have reviewed all of the possible data for the outcomes in the next 10 years and these are your estimates of the Net Present Value of the cash flow and probabilities. High NPV: $5 million, Pr = 0.5 Medium NPV: $2 million, Pr = 0.3 Low NPV: $0, Pr = 0.2 Option B: Retail franchise for Just Hats, a boutique type store selling fashion hats for men and women. This also is a risky opportunity but less so than option A. It has the potential for less risk of failure, but also a lower payoff. You have reviewed all of the possible data for the outcomes in the next 10 years and these are your estimates of the Net Present Value of the cash flow and probabilities. High NPV: $3 million, Pr = 0.75 Medium NPV: $2 million, Pr = 0.15 Low NPV: $1 million, Pr = 0.1 Assignment Develop an analysis of these two investments. Use expected value to determine which of these you should choose. Do your analysis in Excel. Write a report to your private investment company and explain your analysis and your recommendation. Provide a rationale for your decision. Upload both your written report and Excel file to the SLP 2 Dropbox. BONUS: If these two options could be made to be equal, what would have to change in the payoffs in Option A to make it equal to Option B (not the investment amount)? SLP Assignment Expectations Analysis Accurate and complete analysis in Excel. Written Report Length requirements = 2-3 pages minimum (not including Cover and Reference pages) Provide a brief introduction/ background of the problem. Complete and accurate Excel analysis. Written analysis that supports Excel analysis, and provides thorough discussion of assumptions, rationale, and logic used. Complete, meaningful, and accurate recommendation(s) LINEAR REGRESSION FORECASTING AND DECISION TREES Scenario: Using the situation from SLP2, recall that you are deciding between two investments. However, they each require a different initial investment amount. And you also have a third option, to invest in a 10 year municipal bond with a very high return. Here are the investment options with the augmented data. Option A: Real estate development. This is a risky opportunity with the possibility of a high payoff, but also with no payoff at all. You have reviewed all of the possible data for the outcomes in the next 10 years and these are your estimates of the Net Present Value of the cash flow and probabilities. Required initial investment: $0.75 million High NPV: $5 million, Pr = 0.5 Medium NPV: $2 million, Pr = 0.3 Low NPV: $0, Pr = 0.2 Option B: Retail franchise for Just Hats, a boutique type store selling fashion hats for men and women. This also is a risky opportunity but less so than option A. It has the potential for less risk of failure, but also a lower payoff. You have reviewed all of the possible data for the outcomes in the next 10 years and these are your estimates of the Net Present Value of the cash flow and probabilities. Required initial investment: $0.55 million High NPV: $3 million, Pr = 0.75 Medium NPV: $2 million, Pr = 0.15 Low NPV: $1 million, Pr = 0.1 Option C: High Yield Municipal Bonds. This option has low risk and is assumed to be a Certainty. So there is only one outcome with probability of 1.0 Required initial investment: $0.75 million NPV: $1.5 million, Pr = 1.0 Assignment Develop an analysis of these three investments. Use expected NPV to determine which of these you should choose. Be sure to include all cash flows to generate the total NPV of each alternative. Do your analysis in Excel using decision tree. Write a report to your private investment company and explain your analysis and your recommendation. Provide a rationale for your decision. Upload both your written report and Excel file with the decision tree analysis to the SLP 3 Dropbox. BONUS (2.0 pts): If the two options A and B could be made to be equal, what would have to change in the NPVs in Option A to make it equal to Option B? SLP Assignment Expectations Analysis Accurate and complete Excel analysis. Written Report Length requirements = 2-3 pages minimum (not including Cover and Reference pages) Provide a brief introduction/ background of the problem. Complete and accurate Excel analysis. Written analysis that supports Excel analysis, and provides thorough discussion of assumptions, rationale, and logic used. Complete, meaningful, and accurate recommendation(s)