Consider the following new business venture. An agent is considering investment in one of three real estate parcels:
• Option 1: multiunit rentals
• Option 2: commercial building
• Option 3: rural land development
The agent has a five-year time horizon and wishes to evaluate the opportunities irrespective of tax implications. However, the overriding consideration in the geographical market under study is the profitability of the market selected. The agent identified four possibilities as the fastest-growth markets:
• G1: Urban areas are the fastest growth.
• G2: Industrial development is the fastest growth.
• G3: Rural areas will grow most rapidly.
• G4: Growth will be balanced in all three areas.
The agent felt that each event or state of nature (G) was equally likely.
a. What management science tool is best for this problem and why?
b. What action would you recommend in light of the following payoff table? Show your solution in both a decision table and a decision tree. The decision tree may be hand drawn and scanned if you wish.
Option G1 G2 G3 G4
O1 $12,310,000 $10,750,00 $200,000 $35,000,000
O2 $10,860,000 $13,122,000 $500,000 $27,000,000
O3 $600,000 $9,900,000 $6,450,000 $21,000,000
c. A research firm has completed a growth study and has made projections. Its studies have been 95 percent reliable in the past, but you wonder if the new study will be worth its $700,000 price tag. The firm will sell the study only to one party who will retain proprietary rights.
d. Assume that you purchased the research that then showed:
• Pr(G1) = 0.10
• Pr(G2) = 0.20
• Pr(G3) = 0.45
• Pr(G4) = 0.25
What action would you take? What is the expected payoff? How sensitive is the action to changes in the probabilities?
e. If you were the agent in this case would you use these results, modify them or ignore them? Justify your answer.