Decision Analysis Case: Property Purchase Strategy

Decision Analysis Case Problem Property Purchase Strategy

Glenn Foreman, president of Oceanview Development Corporation, is considering submitting a bid to purchase property at a county tax foreclosure auction. The bid must be submitted by August 15, with the auction results announced on September 1. The property is currently zoned for single-family residences only, but a referendum might be placed on the November ballot to change the zoning to permit condominiums. If the zoning change is approved, Oceanview plans to build and sell luxury condominiums; if rejected, the firm would likely abandon the purchase to avoid further costs.

Glenn estimates that submitting a $5 million bid gives Oceanview a 0.2 chance of winning the auction. To secure the bid, Oceanview must provide a 10% deposit, which will be forfeited if the bid is accepted but the firm fails to complete the purchase within six months. The current evaluation suggests a 0.3 probability that the zoning referendum will be approved, but Oceanview considers conducting a survey to improve this estimate. The survey would cost $15,000 and be available by August 1, providing more accurate information about voter support.

The preliminary analysis estimates that if the zoning changes to permit condominiums, the project would generate $15 million in revenue and incur $8 million in construction and property costs. If the zoning is rejected after the referendum and Oceanview proceeds with the purchase, the best course would be to forgo construction and incur only the deposit loss.

This report analyzes the decision problem faced by Oceanview Development, including decision tree construction, evaluation of options without market research, and recommendations with and without conducting the survey. The goal is to determine the optimal course of action that maximizes expected value under the uncertainty of zoning approval and auction outcomes.

Paper For Above instruction

The decision-making process for Oceanview Development Corporation regarding the potential property purchase involves complex uncertainties surrounding the auction outcome, zoning approval, and the financial viability of the condominium project. By carefully analyzing these factors, Oceanview can implement a rational strategy that maximizes its expected benefits while minimizing potential losses.

Decision Tree Construction

The core of the analysis begins with constructing a decision tree that encapsulates all possible decisions and outcomes. The decision nodes include whether to bid or not, whether to conduct a market research survey, and whether to proceed with the purchase based on the survey results and zoning outcome. Chance nodes represent the probabilities of winning the auction, approval of zoning change, and the accuracy of the survey.

Initially, the firm faces the decision to bid or not. If they decide to bid, they must consider the probability of winning (0.2) given their bid of $5 million, resulting in a winning or losing node. If they win, the subsequent step hinges on whether the zoning referendum passes, with initial estimates of 0.3 probability. The survey, if conducted, can refine this estimate, influencing the decision to proceed with the purchase.

The likelihood of achieving the desired zoning change is therefore a critical factor. If the referendum passes, the expected revenue from selling condominiums minus costs is significant, favoring purchase. If rejected, the firm loses only the deposit, which is a relatively small downside. The decision tree visually maps these sequential steps to facilitate quantitative analysis.

Decision Without Market Research

Without the benefit of market research, Oceanview faces a straightforward choice: either bid or abstain. Given the probability of winning the auction (0.2) and the expected value of the project conditional on zoning approval, the firm can calculate the overall expected value of bidding. The expected value (EV) of bidding can be computed as:

• EV if bidding and winning: (Probability of winning) × (Probability of zoning approval) × (Revenues minus costs)
• EV if bidding and losing: (Probability of losing) × (cost of deposit)

Specifically, the calculation assumes a 0.3 chance of zoning approval, so expected revenues are high if zoning passes, and costs are limited to the deposit if it fails or if they decide not to proceed after the zoning rejection post-purchase.

Given the initial probabilities and estimates, a quantitative analysis can help determine whether bidding is a rational decision financially. If expected gains outweigh the costs, Oceanview should proceed; otherwise, abstaining would be prudent.

Decision Strategy with Market Research

If the market research is conducted, the survey's accuracy can significantly influence the decision. Assuming the survey costs $15,000 and provides a more accurate estimate of voter support, the expected value calculation must incorporate the probability that the survey correctly predicts the referendum outcome.

The survey's accuracy metrics show a high likelihood of correct predictions, which informs Bayesian updating of the initial 0.3 probability. If the survey indicates support, the probability of zoning approval increases; if it indicates rejection, the probability decreases. Consequently, Oceanview can adopt a conditional decision strategy:

• If survey predicts support, proceed with bidding, as the likelihood of success is higher.
• If survey predicts rejection, abstain from bidding to avoid potential losses.

This approach maximizes the expected value by integrating the improved information from the survey and avoiding unnecessary expenditure if the prognosis is unfavorable.

Recommendation on Employing the Market Research Firm

The key consideration relates to whether the value of information gained from the survey justifies its cost. By calculating the expected increase in value from better decision-making, Oceanview can determine if hiring the survey firm is advantageous. This involves evaluating the expected increase in probabilities of favorable outcomes based on survey accuracy and the resultant impact on expected revenues.

Given the estimated accuracy, the benefits of reducing uncertainty outweigh the $15,000 survey cost. The enhanced information allows for more precise decision-making, decreasing the risk of investing in an unsuccessful project and increasing the likelihood of capturing high-value opportunities if the referendum passes.

Thus, the recommended course of action is to employ the market research firm, as the expected incremental value of improved information surpasses the survey cost, aligning with principles of optimal decision analysis.

Conclusion

In summary, Oceanview Development should undertake a structured decision analysis, including constructing a decision tree and using probabilistic evaluation to inform their strategies. Without market research, the firm should carefully analyze expected values and possibly abstain from bidding if the risks outweigh potential rewards. If employing market research is considered, it offers valuable information that can significantly enhance decision quality, and the firm should invest in the survey given the estimated accuracy and potential for higher expected returns. Overall, a strategic, data-driven approach facilitates optimal decision-making in complex, uncertain scenarios such as property purchases and zoning changes.

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