Dante Development Corporation is considering bidding on a contract for a new off
ID: 1226322 • Letter: D
Question
Dante Development Corporation is considering bidding on a contract for a new office building complex. The figure below shows the decision tree prepared by one of Dante's analysts. At node 1, the company must decide whether to bid on the contract. The cost of preparing the bid is dollar200,000. The upper branch from node 2 shows that the company has a 0.8 probability of winning the contract if it submits a bid. If the company wins the bid, it will have to pay dollar2,000,000 to become a partner in the project. Node 3 shows that the company will then consider doing a market research study to forecast demand for the office units prior to beginning construction. The cost of this study is dollar 50,000. Node 4 is a chance node showing the possible outcomes of the market research study. Nodes 5, 6, and 7 are similar in that they are the decision nodes for Dante to either build the office complex or sell the rights in the project to another developer. The decision to build the complex will result in an income of dollar5,000,000 if demand is high and dollar3,000,COO if demand is moderate. !f Dante chooses to sell its rights in the project to another developer, income from the sale is estimated to be dollar3,500,000. The probabilities shown at nodes 4. 8, and 9 are based on the projected outcomes of the market research study. Verify Dante's profit projections shown at the ending branches of the decision tree by calculating the payoffs of dollar2,650,000 and dollar650,000 for first two outcomes. Are the profit projections correct? What is the optimal decision strategy for Dante, and what is the expected profit for this project? What would the cost of the market research study have to be before Dante would change its decision about the market research study? Market research cost would have to be lowered to dollar 2650000 or less to make undertaking the research desirable.Explanation / Answer
b. Expected Profit = 0.8[0.6*2800 + 0.4*800] - 0.2*200 = 1560,000
c. Expected value of profit in case market research = expected value of profit in case of no market research
Expected value of profit in case market research = 0.8[0.6(0.85*2650 + 0.15*650) + 0.4(0.225*2650 + 0.775*650)] - 0.2*200 = 1440,000
So, Market research cost should come down to = 1560,000 - 1440,000 = 120,000
If you don't understand anything then comment, I'ill revert back on the same. :)
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.