Question

The Place-Plus real estate development firm is dissatisfied with the economist’s estimate of the

probabilities of future interest rate movement, so it is considering having a financial consulting firm

provide a report on future interest rates. The consulting firm is able to cite a track record which

shows that 80% of the time when interest rates declined, it had predicted they would, whereas 10%

of the time when interest rates declined, the firm had predicted they would remain stable and 10%

of the time it had predicted they would increase. The firm has been correct 70% of the time when

rates have remained stable, whereas 10% of the time it has incorrectly predicted that rates would

decrease, and 20% of the time it has incorrectly predicted that rates would increase. The firm has

correctly predicted that interest rates would increase 90% of the time and incorrectly predicted rates

would decrease 2% and remain stable 8% of the time. Assuming that the consulting firm could

supply an accurate report, determine how much PlacePlus should be willing to pay the consulting

firm. [