Decision Analysis Problem: You are a potential business owner in the hoomaflopper industry. You have hired Dustin R. Mopps as your industry insider to help you decide which businesses to focus on potentially buying. He has collected useful data from multiple sources for you. The problem with Mr. Mopps is that he is a terrible decision analyst. So, it is up to you to figure out what to do.
Dustin found a business for you to look into for a possible purchase: property ID number 51 in your data set, valued at $188,000. If this property is indeed viable, it is estimated to earn you $500,000 in the first year of business. However, you will have to pay $60,000 to perform a systems audit and refurbish it right after you buy it. Your back-of-the-envelope estimate is that there is X chance that you could realize the $500,000. You will need to spend a little time to figure out X for your model.
Alternatively, you could hire Dustin to first do some real estate legwork for you, since real estate data is his specialty. He will ask for $16,000 to do further market research for you. From sneakily talking to his other clients, you estimate the probability as 60% that Dustin’s market research will be favorable, if the business is going to be viable. The probability of an unfavorable report from Dustin is 70% if the business will not be viable. In other words, you trust him, but not that much. He might be able to give you an edge. You need to know if it is worth paying him the $16,000 or not. Keep all of these values in mind for your conditional probability calculations.
1. Open the ProblemSet 5 Tree file in Excel
a. Using the information provided with the problem, fill in all of the blue cells on the Excel worksheet.
c. Calculate the sheet (hit F9)
3. Provide the answers to the questions that follow:
a. Describe and interpret what is going on in this tree in about 250 words.
b. Include a discussion on what the optimal strategy is and why is it the optimal strategy?
c. Include a statement of what the expected value is? What does expected value mean here?
d. Change the values in cells B:20 to B:26. These contain the costs and payouts. Change these one at a time and calculate sheet. Discuss what threshold values flip the decision tree to recommending a different strategy?
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