Roger Dirt, owner of Newview Development Corporation is considering submitting a bid to purchase property that will be sold by sealed bid at a county tax foreclosure. The company’s bid team suggests a bid of $5 million. Based on experience, the CEO estimates the probability of winning such a bid at 0.2.
If Newview submits the highest bid, the firm plans to build luxury condominiums on the property. However, the property is zoned for single-family residences only, so the company would have to petition for a referendum in the upcoming election to get the zoning changed. Newview estimates costs of $50,000 to get the measure on the ballot. If the zoning could not be changed, the company would abandon the project.
The sealed-bid procedure requires the bid to be submitted with a certified check for 10% of the bid amount (negative cash flow when the bid is made). If the bid is accepted, the deposit is treated as a down payment on the property (and subtracted from payment for the land when the purchase is finalized). If the bid is rejected, the deposit is refunded (positive cash flow upon losing the bid). If the bid is accepted, but the bidder doesn’t follow through with buying the property, the deposit is forfeited. The timing of election day allows for the referendum to be held before the decision must be made whether or not to follow through with the purchase. Newview will only complete the purchase of the land if it has decided to build the condos.
Preliminary analysis estimates the probability of a successful referendum to be 0.3, the cost to build the condos (on top of the $5 million for the land) to be $8 million, and the revenue from the condo sales to be $15 million.
Create and submit a decision tree modeling the details of Newview’s decision. Please label branches of the decision tree with discernable descriptions (e.g. “Bid” and “Don’t Bid” rather than “Yes” and “No”). Also, please enter monetary value in $Thousands. Be sure that all cash flows/payoffs, probabilities, and EVs are present where applicable.