Question

*****PLEASE ONLY ANSWER PART C******

A real estate investor has the opportunity to purchase land currently zoned as residential. If the county board approves a request to rezone the property as commercial within the next year, the investor will be able to lease the land to a large discount firm that wants to open a new store on the property. However, if the zoning change is not approved, the investor will have to sell the property at a loss. Profits (in thousands of dollars) are shown in the following payoff table:

	State of Nature
	Rezoning Approved	Rezoning Not Approved
Decision Alternative	s1	s2
Purchase, d1	600	-200
Do not purchase, d2	0	0

(a)	If the probability that the rezoning will be approved is 0.5, what decision is recommended?
	Recommended Decision: - Select your answer -PurchaseDo not purchaseItem 1
	What is the expected profit? Enter your answer in thousands dollars. For example, an answer of $200 thousands should be entered as 200,000.
	$
(b)	The investor can purchase an option to buy the land. Under the option, the investor maintains the rights to purchase the land anytime during the next three months while learning more about possible resistance to the rezoning proposal from area residents. Probabilities are as follows:
	Let H = High resistance to rezoning
	L = Low resistance to rezoning
	P(H) = 0.55  P(s1 | H) = 0.18  P(s2 | H) = 0.82
	P(L) = 0.45  P(s1 | L) = 0.89  P(s2 | L) = 0.11
	What is the optimal decision strategy if the investor uses the option period to learn more about the resistance from area residents before making the purchase decision?
	High resistance: - Select your answer -PurchaseDo not purchaseItem 3 Low resistance: - Select your answer -PurchaseDo not purchaseItem 4
(c)	If the option will cost the investor an additional $10,000, should the investor purchase the option? Enter your answer in thousands dollars. For example, an answer of $200 thousands should be entered as 200,000.
	- Select your answer -YesNoItem 5
	Why or why not?
	The input in the box below will not be graded, but may be reviewed and considered by your instructor.
	What is the maximum that the investor should be willing to pay for the option?
	EVSI = $

Answer 1

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Answer 2

Given that

A real estate investor has the opportunity to purchase land currently zoned as residential

Purchase, d1 600

Don't purchase, d2 0

c) If the option will cost the investor an additional $10,000 the the expected profit of the recommended = 200 thousands of Dollars - $10,000

= 190 thousands of Dollars

As, the expected profit is still greater than 0 the investor should purchase the option

The maximum that the investor should be willing to pay for the option is the expected profit of the recommended decision = 200 thousands of Dollars.

Answer 3

Solution:-

(C):-

Here consider the Expected profit,

Now from given data, Expected profit = ( 0.5 * $600) + (0.5*-$200)

Expected profit = 300 + (-100)

Expected profit= $200 thousands of dollars

Here consider the payoffs for d1 and d2.

At high resistance:

Payoff for d1 = [0.18 * $600] + [0.82*(-$100)]

= 108 - 82

= $26 thousands of dollars

Payoff for d2 = 0

i.e, Don't purchase

At high resistance:

Payoff for d1 = [0.89 * $600] + [0.11*(-$100)]

= 534 - 11

= $523 thousands of dollars

Payoff for d2 = 0

i.e, Purchase the item

Now consider expected profit from the option,

Expected profit = (0.55 * $0) + (0.45 * $523 )

Expected profit = 0 + 235.35

Expected profit from the option= $235.35

Then required is, EVSI = Expected profit from the option - Expected profit = $235.35 - $200

EVSI = $35.35 thousands of dollars.

Hence, we can say that, the Option should be purchased as it improves the value by $35.35 thousands of dollars.

Therefore, the maximum amount that the investor should be willing to pay for the option is $35.35 thousands of dollars.

Answer 4

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