Property Purchase Strategy

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 0.25 probability of being the highest bid and securing the property for Oceanview (i.e., winning the bid). The current date is June 1. Sealed bids for the property must be submitted by August 15. The winning bid will be announced on September 1. If Oceanview Corporation submits the highest bid and obtains the property, the firm plans to build and sell a complex of luxury condominiums. However, a complicating factor is that the property is currently zoned for single-family residences only. Glenn Foreman 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. The sealed-bid procedure requires the bid to be submitted with a certified check for 10% 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. To determine whether Oceanview should submit the $5.5 million bid, Glenn conducted some preliminary analysis. This preliminary work provided an assessment of 0.4 for the probability that the referendum for a zoning change will be approved and resulted in the following estimates of the cost and revenues that will be incurred if the condominiums are built: Cost and Revenue Estimates Revenue $17,000,000 Cost Property $5,500,000 Construction expenses $8,500,000 If Oceanview Corporation obtains the property and the zoning change is rejected in November, Glenn believes that the best option would be for the firm not to complete the purchase of the property. In this case, Oceanview would forfeit the 10% deposit that accompanied the bid. Because the likelihood that the zoning referendum will be approved is such an important factor in the decision process, Glenn suggested that the firm hire a market research service to conduct a survey of voters. The survey would provide a better estimate of the likelihood that the referendum for a zoning change would be approved. The market research firm that Oceanview Development has worked with in the past has agreed to do the study for $20,000. The results of the study will be available August 1, so that Oceanview will have this information before the August 15 bid deadline. The results of the survey will be either favorable (i.e., a prediction that the zoning change will be approved) or unfavorable (i.e., a prediction that the zoning change will be rejected). After considering the record of the market research service in previous studies conducted for Oceanview Corporation, Glenn developed the following probability estimates concerning the accuracy of the market research information: P(Favorable survey result | tℎe zoning cℎange is approved by tℎe voters) = 0.85 P(Unfavorable survey result | tℎe zoning cℎange is approved by tℎe voters) = 0.15 P(Favorable survey result | tℎe zoning cℎange is rejected by tℎe voters) = 0.26 P(Unfavorable survey result | tℎe zoning cℎange is rejected by tℎe voters) = 0.74 Managerial Report Perform an analysis of the problem facing the Oceanview Development Corporation, and prepare a report that summarizes your findings and recommendations. Include the following items in your report: 1. A simple decision tree that shows the logical sequence of the decision problem and a recommendation regarding what alternative Oceanview should take. 2. The calculation of posterior probabilities (keep the answer to 3 decimal places) and a complex tree showing the posterior probabilities, payoffs, and expected monetary values. 3. The value of the sample information provided by the market research firm (EVSI) and the efficiency of this information. 4. The optimal decision strategy that Oceanview Development Corporation should follow, including a recommendation as to whether Oceanview Development Corporation should employ the market research firm and the recommended alternative they should take following this recommendation.