Question

Place-Plus, a real estate development firm, is considering several alternative development projects. These include building and leasing an office park, purchasing a parcel of land and building an office building to rent, buying and leasing a warehouse, building a strip mall, and selling condominiums. The financial success of these projects depends on interest rate movement in the next 5 years. The various development projects and their 5- year financial return (in $1,000,000s) given that interest rates will decline, remain stable, or increase, are in the following payoff table. Place-Plus real estate development firm has hired an economist to assign a probability to each direction interest rates may take over the next 5 years. The economist has determined that there is a 0.45 probability that interest rates will decline, a 0.35 probability that rates will remain stable, and a 0.2 probability that rates will increase. a. Using expected value, determine the best project. b. Determine the expected value of perfect information

Interest Rate

Project

Decline Stable Increase

Office park $0.4 $1.55 $3.5

Office building 2.5 1.8 2.75

Warehouse 1.7 1.45 1.5

Mall 0.8 2.3 3.5

Condominiums 3.2 1.5 0.5

to be done in excel

Answer 1

Office building will be the best project as per expected value.

A pessimistic manager would use the Maximin criterion

	Minimum Payoff
Office Park	0.5
Office Building	1.5	?Maximum
Warehouse	1.0
Shopping Center	0.7
Condominiums	0.6

Because of their lack of knowledge about interest rate movements the management of Place-Plus has hired an economist to assign a probability to each direction interest rates may take over the next five years. The economist has determined that there is a .50 probability that interest rates will decline, a .40 probability that rates will remain stable, and a .10 probability that rates will increase.

If management is risk neutral, what decision should they make? Why?

P(Decline)=.5 P(Stable)=.4 P(Increase)=.1

ER(Office Park)=.5(.5)+.4(1.7)+.1(4.5)=1.38

ER(Office Building)=.5(1.5)+.4(1.8)+.1(2.4)=1.75

ER(Warehouse)=.5(1.7)+.4(1.4)+.1(1.0)=1.51

ER(Shopping Center)=.5(.7)+.4(2.4)+.1(3.6)=1.67

ER(Condominiums)=.5(3.2)+.4(1.5)+.1(.6)=2.26

Choose Condominiums since they have the largest expected return.

To continue the analysis the economist asks the management of Place-Plus to consider two different hypothetical development projects. One project has a projected five year return of $0. The second hypothetical project has a .50 probability of producing a $1.0 million five year return and a .50 probability of producing a -$0.5 million five year return.

Assume that management indicates that they are indifferent about these two hypothetical projects. Use this information and the payoff table and probabilities in parts a. and b. to determine what decision Place-Plus should make about their real project alternatives.

U(x)=1-e-x where x is the payoff from the payoff table

	Decline	Stable	Increase	Expected Utility
Office Park	.39	.82	.99	.622
Office Building	.78	.85	.91	.821
Warehouse	.82	.75	.63	.773
Shopping Center	.50	.91	.97	.711
Condominiums	.96	.78	.45	.837
Probabilities	.5	.4	.1

Choose Condominiums since it has the highest expected utility.

NOTE: {this is similar answer to given question... please change the values}