Glenn Foreman, president of Oceanview Development Corporation, is considering submitting a bid to purchase property that will be sold by sealed bid at a county tax foreclosure. Glenn’s initial judgment is to submit a bid of $5.5 million. Based on his experience, Glenn estimates that a bid of $5.5 million will have a 0.2 probability of being the highest bid and securing the property for Oceanview.
The sealed-bid procedure requires the bid to be submitted with a certified check for 8% of the amount bid. If the bid is rejected, the deposit is refunded. If the bid is accepted, the deposit is the down payment for the property. However, if the bid is accepted and the bidder does not follow through with the purchase and meet the remainder of the financial obligation within six months, the deposit will be forfeited. In this case, the county will offer the property to the next highest bidder.
If Oceanview’s bid is accepted and they obtain the property, the firm has to decide between building and selling a complex of luxury condominiums or building and selling a complex of single family residences. However, a complicating factor is that the property is currently zoned for single-family residences only. Glenn believes that a referendum could be placed on the voting ballot in time for the November election. Passage of the referendum would change the zoning of the property and permit construction of the condominiums. To determine whether Oceanview should submit the $5 million bid, Glenn conducted some preliminary analysis. This preliminary work provided an assessment of a 40% the probability that the referendum for a zoning change will be approved.
Cost and Revenue Estimates-
Condominiums Revenue from condominium sales: $16,000,000 with a probability of 75% or 7,000,000 with a probability of 25%
Cost: Construction expenses of $7,500,000
Cost and Revenue Estimates- Single Family Homes Revenue from home sales: $12,000,000 with a probability of 70% or 6,000,000 with a probability of 30%
Cost: Construction expenses of $6,000,000
a. Draw the decision tree for this problem.
b. Calculate the expected values and determine the best decision for Oceanview.