Assignment:
The owner of the Columbia Construction Company must decide between building a housing development, constructing a shopping center, and leasing all the company's equipment to another company. The profit that will result from each alternative will be determined by whether material costs remain stable or increase, as shown in the following payoff table:
Material Costs
|
Material Cost |
Material Cost |
| Decision |
Stable |
Increase |
| Houses |
$70,000 |
$30,000 |
| Shopping center |
$105,000 |
$20,000 |
| Leasing |
$40,000 |
$40,000 |
a. Assume that it is equally likely that material costs will be stable or increase. What is the probability that they are stable?
b. Draw the payoff table as a decision tree.
c. What is the certain equivalent for each alternative for a risk-neutral decision maker?
d. Based on the CE, which alternative would our decision maker select?
e. What is the value of clairvoyance? Interpret.