What is the real option value of opening the concept store in New York City? Hint: Use the tree model to consider under which scenario(s) Zorbas Bakeries would open the second store.
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A major retail clothing store is considering whether to open a new store on the other side of town or wait one year and then open the store. In the meantime, they have paid $10,000 for a one-year option on a building. If they open the store now, it will cost $140,000 to refurbish it, but it will cost $160,000 if they wait one year. They expect sales to depend on the economy in the area at the time they open the store. If they go ahead now, there is a 50% chance the economy will go up, 30% it will stay the same, and 20% it will go down. They then expect the following returns: if the economy goes up $200,000; stays the same $160,000; and goes down -$20,000. If they wait one year, they can either open the store then or not open the store and let the option expire. If the option expires, they will lose the $10,000. One year from now, they expect there is a 40% chance the economy will go up, 30% stay the same, and 30% go down. The returns they expect to get would then be: if the economy goes up $180,000; stays the same $160,000; and goes down -$30,000. a. Using decision tree analysis, what is the expected value of opening the store now? b. Using decision tree analysis, what is the expected value of waiting one year to open the store? c. What should the company do, and what is the expected value of that decision?
Aishwarya K.
The owners of Sweet-Tooth Bakery have determined that they need to expand their facility in order to meet their increased demand for baked goods. The decision is whether to expand now with a large facility or expand small with the possibility of having to expand again in five years. The owners have estimated the following chances for demand: - The likelihood of demand being high is 0.70. - The likelihood of demand being low is 0.30. Profits for each alternative have been estimated as follows: - Large expansion has an estimated profitability of either $80,000 or $50,000, depending on whether demand turns out to be high or low. - Small expansion has a profitability of $40,000, assuming demand is low. - Small expansion with an occurrence of high demand would require considering whether to expand further. If the bakery expands at this point, the profitability is to be $50,000. (a) Draw a decision tree showing the decisions, chance events, and their probabilities, as well as the profitability of outcomes. (b) Solve the decision tree and decide what the bakery should do.
Dominador T.
Question 5) A company wanting to build a hotel in downtown St. John's needs to buy two adjacent properties. The appraised values for Properties 1 and 2 are $1,000,000 and $2,600,000 respectively. They can try to buy these properties (by making separate offers to the two owners) for 50% more than the appraised value, for which there is a 75% chance that the owner of Property 1 would agree to sell, and an 80% chance that the owner of Property 2 would agree to sell. If an offer at 1.5 times appraised value is turned down, they could then offer double the appraised value for that property, for which it is certain that the owner (of either property) would agree to sell. Ending up with no properties is worth nothing; ending up with just one property is worth only the appraised value of that one property; ending up owning both is worth $6,000,000. (a) Given that at the outset any offer to buy would be made to both owners simultaneously, draw a decision tree to determine what the hotel developer should do. (Hint: You might find it easier to embed all costs at the end.) (b) Determine the EVPI by any method.
Akash M.
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