The lease of Theme Park, Inc., is about to expire. Management must decide whethe
ID: 415782 • Letter: T
Question
The lease of Theme Park, Inc., is about to expire. Management must decide whether to renew the lease for another 10 years or to relocate near the site of a proposed motel. The town planning board is currently debating the merits of granting approval to the motel. A consultant has estimated the net present value of Theme Park's two alternatives under each state of nature as shown below. Suppose that the management of Theme Park, Inc., has decided that there is a 0.27 probability that the motel's application will be approved Motel Motel OptionsApproved Renew Relocate Rejected $700,000 $4,000,000 400,000 5,000,000 a-1. If management uses maximum expected monetary value as the decision criterion, calculate expected monetary value for the alternatives "Renew" and "Relocate"? (Omit the "$" sign in your response.) Alternative Renew Relocate cted Value $3109000 s1642000 a-2. Which alternative should it choose? O Relocate Renew c. If management has been offered the option of a temporary lease while the town planning board considers the motel's application, would you advise management to sign the lease? The lease will cost $24,000. (Omit the "$" sign in your response.) because the cost is lessthan EVPl of s Yes than EVPI of $Explanation / Answer
a-1.
Expected Monetary Value (EMV) of Renew decision = 0.27*700000 + (1-0.27)*4000000 = $ 3,109,000
Expected Monetary Value (EMV) of Relocate decision = 0.27*5000000 + (1-0.27)*400000 = $ 1,642,000
a-2. EMV of Renew is higher. therefore, choose Renew
c. By signing the lease, at the end of the temporary lease period, there would be perfect information about the approval or rejection. Therefore, management would choose the option that would maximize the payoff.
Expected Value with Perfect Information (EVwPI) = 0.27*MAX{700000, 5000000} + (1-0.27)*MAX{4000000, 400000}
= 0.27*5000000 + 0.73*4000000
= $ 4,270,000
EVPI = EVwPI - EMVmax = 4,270,000 - 3,109,000 = $ 1,161,000
Yes, because the cost less than EVPI of $ 1,161,000
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