Assignment:
Review the below Case:
Bill Holliday is not sure what she should do. He can build a quadplex (i.e., a building with four apartments), build a duplex, gather additional information, or simply do nothing. If he gathers additional information, the results could be either favorable or unfavorable, but it would cost him $3,000 to gather the information. Bill believes that there is a 50-50 chance that the information will be favorable. If the rental market is favorable, Bill will earn $15,000 with the quadplex or $5,000 with the duplex. Bill doesn't have the financial resources to do both. With an unfavorable rental market, however, Bill could lose $20,000 with the quadplex or $10,000 with the duplex. Without gathering additional information, Bill estimates that the probability of a favorable rental market is 0.7 A favorable report from the study would increase the probability of a favorable rental market to 0.9 Furthermore, an unfavorable report from the additional information would decrease the probability of a favorable rental market to 0.4. Of course, Bill could forget all ofthese numbers and do nothing. What is your advice to Bill?
A) Draw the decision tree for the problem. Make sure to include all the nodes for the decisions and states of nature, all the probabilities and all the payoffs in the decision tree.
B) Calculate the EMV at each state of nature node.
C) Based on the EMV values calculated, what is your advice to Bill?