Problem:
Emaar is a real estate company based in Dubai and is considering for constructing three kinds of housing complexes. The three kinds of complexes are: small complex, medium complex and large complex. When asked about the possible demand for the houses, the president of the Emaar Company acknowledged a wide range of possibilities but decided that it would be adequate to consider only two possible chance event outcomes: a strong demand and a weak demand.
The probabilities for the two states of nature are 0.8 for a strong demand and 0.2 for a weak demand. The payoff table with profits expressed in millions of Dirhams is shown in the table below:
|
ALTERNATIVE
|
Strong demand (Dirham)
|
Weak Demand (Dirham)
|
|
Small complex
|
7
|
7
|
|
Medium complex
|
12
|
5
|
|
Large complex
|
20
|
-8
|
|
Probability
|
0.8
|
0.2
|
a) Using an appropriate technique in decision making under risk what would you recommend to the trader?
b) What is the Expected Value of Perfect Information (EVPI)?
c) What is the Expected Opportunity Loss (EOL)? for the recommended decision alternative
Additional Information:
This question basically belongs to Finance as well as it explains about a real estate company considering constructing three kinds of housing complexes. The kind of complex to be constructed and which can be most profitable with highest demand has to be selected; along with the expected value as well as expected opportunity loss has been discussed in the solution.