Case 1 : 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 $\$ 5$ million. Based on his experience, Glenn estimates that a bid of $\$ 5$ million will have a $0.2$ probability of being the highest bid and securing the property for Oceanview. 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 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 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 $\$ 5$ million bid, Glenn conducted some preliminary analysis. This preliminary work provided an assessment of $0.3$ for the probability that the referendum for a zoning change will be approved and resulted in the following estimates of the costs and revenues that will be incurred if the condominiums are built.

If Oceanview 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 percent 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 $\$ 15,000$. 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 a prediction that the zoning change will be approved or a prediction that the zoning change will be rejected. After considering the record of the market research service in previous studies conducted for Oceanview, Glenn developed the following probability estimates concerning the accuracy of the market research information.

where

\(A=\) prediction of zoning change approval

\(N=\) prediction that zoning change will not be approved

\(s_{1}=\) the zoning change is approved by the voters

\(s_{2}=\) the zoning change is rejected by the voters

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 decision tree that shows the logical sequence of the decision problem
2. A recommendation regarding what Oceanview should do if the market research information is not available
3. A decision strategy that Oceanview should follow if the market research is conducted
4. A recommendation as to whether Oceanview should employ the market research firm, along with the value of the information provided by the market research firm Include the details of your analysis as an appendix to your report.

Solution:

1. First of all, we compute the following probabilities
   P(Approval) = 0.9*0.3+0.2*0.7 = 0.41
   P(Rejection) = 1- 0.41 = 0.59
   Also, using Bayes Theorem, we find that
   P(s ₁ |A) = 0.6585
   P(s ₂ |A) = 0.3415
   P(s ₁ |N) = 0.0508
   P(s ₂ |N) = 0.9492
   We have the following decision tree (due to size constraints, the tree is divided into its two main branches)
   
   
2. If market research is not available, the best option would be to make a bid (because that option has an expected value of $50,000, whereas not submitting has a expected value of $0)
3. If the market research is conducted, the best option would be to bid if approval is predicted, and not to bid if rejection is predicted.
4. Overall, the best option is to employ the market research firm, because they lead to an overall expected value of $78,992.5 (versus $50,000 of the option of not using the market research firm).

Case 2: Lawsuit Defense Strategy

John Campbell, an employee of Manhattan Construction Company, claims to have injured his back as a result of a fall while repairing the roof at one of the Eastview apartment buildings. He filed a lawsuit against Doug Reynolds, the owner of Eastview Apartments, asking for damages of $\$ 1,500,000$. John claims that the roof had rotten sections and that his fall could have been prevented if Mr. Reynolds had told Manhattan Construction about the problem. Mr. Reynolds notified his insurance company, Allied Insurance, of the lawsuit. Allied must defend Mr. Reynolds and decide what action to take regarding the lawsuit.

Some depositions and a series of discussions took place between both sides. As a result, John Campbell offered to accept a settlement of $\$ 750,000$. Thus, one option is for Allied to pay John $\$ 750,000$ to settle the claim. Allied is also considering making John a counteroffer of $\$ 400,000$ in the hope that he will accept a lesser amount to avoid the time and cost of going to trial. Allied's preliminary investigation shows that John's case is strong; Allied is concerned that John may reject their counteroffer and request a jury trial. Allied's lawyers spent some time exploring John's likely reaction if they make a counteroffer of $\$ 400,000$.

The lawyers concluded that it is adequate to consider three possible outcomes to represent John's possible reaction to a counteroffer of $\$ 400,000:$ (1) John will accept the counteroffer and the case will be closed; (2) John will reject the counteroffer and elect to have a jury decide the settlement amount; or (3) John will make a counteroffer to Allied of $\$ 600,000$. If John does make a counteroffer, Allied decided that they will not make additional counteroffers. They will either accept John's counteroffer of $\$ 600,000$ or go to trial.

If the case goes to a jury trial, Allied considers three outcomes possible: (1) the jury may reject John's claim and Allied will not be required to pay any damages; (2) the jury? will find in favor of John and award him $\$ 750,000$ in damages; or (3) the jury will conclude that John has a strong case and award him the full amount of $\$ 1,500,000$.

Key considerations as Allied develops its strategy for disposing of the case are the probabilities associated with John's response to an Allied counteroffer of $\$ 400,000$ and the probabilities associated with the three possible trial outcomes. Allied's lawyers believe the probability that John will accept a counteroffer of $\$ 400,000$ is $0.10$, the probability that John will reject a counteroffer of $\$ 400,000$ is $0.40$, and the probability that John will, himself, make a counteroffer to Allied of $\$ 600,000$ is $0.50$. If the case goes to court, the believe that the probability the jury will award John damages of $\$ 1,500,000$ is $0.30$, the probability that the jury will award John damages of $\$ 750,000$ is $0.50$, and the probability that the jury will award John nothing is $0.20$.

Managerial Report

Perform an analysis of the problem facing Allied Insurance and prepare a report that summarizes your findings and recommendations. Be sure to include the following items:

1. A decision tree
2. A recommendation regarding whether Allied should accept John's initial offer to settle the claim for $\$ 750,000$
3. A decision strategy that Allied should follow if they decide to make John a counteroffer of $\$ 400,000$
4. A risk profile for your recommended strategy

Solution: 1. The following decision tree is obtained:

2. Based on the expected values obtained in the decision tree, we conclude that Allied should counteroffer. In fact, the expected cost of counter offering is $670,000, as opposed to the $750,000 that would cost to settle.

3. If they make the counteroffer, they should settle for $600,000 if John counteroffers.

4. We have the following risk profile

Price: $24.42

Solution: The downloadable solution consists of 10 pages, 1442 words and 4 charts.
Deliverable: Word Document