A real estate investor has the opportunity to purchase land currently zoned resi

Question

A real estate investor has the opportunity to purchase land currently zoned residential. If the county board approves a request to rezone the property as commercial within the next year, the investor will be able to lease the land to a large discount firm that wants to open a new store on the property. However, if the zoning change is not approved, the investor will have to sell the property at a loss. Profits (in thousands of dollars) are shown in the following payoff table:

Explanation / Answer

a) Recommended decision = Purchase the property

Expected profit = 0.5*$500 + 0.5*-$170 = $165, 000

b)

In case of high resistance,

Payoff for d1 = 0.15*$550 + 0.85*-$170 = -$62, 000

Payoff for d2 = 0

Hence, Do not purchase

In case of low resistance

Payoff for d1 = 0.88*$550 + 0.12*-$170 = $463, 600

Payoff for d2= 0

Hence, purchase the item

c)

Expected profit from option = 0.53*$0 + 0.47*$463, 600 = $217, 892

EVSI = $217, 892 - $165, 000 = $52, 892

Option should be purchased as it improves the value by $52, 892.

d)

Maximum amount that the investor should be willing to pay for the option = $52,892

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