Question

3. 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 building 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 shown in the following payoff table:

		Interest Rate
Project	Decline	Stable	Increase
Office park	$0.5	$1.7	$4.6
Office building	1.5	1.9	2.5
Warehouse	1.7	1.4	2.0
Mall	0.7	2.4	3.6
Condominiums	3.2	1.5	0.8

The 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 .50 probability that interest rates will decline and .40 probability that rates will remain stable.

a. Using expected value, determine the best project.

b. Using expected regret (opportunity loss), determine the best project.

c. What is the maximum amount the Place-Plus CEO would be willing to pay for the perfect insider information? Calculate.

.

Answer 1