Case Study

Topics: Decision theory, Risk, Decision making Pages: 8 (2284 words) Published: October 21, 2010
Executive Summary
This report analyses Oceanview Development Corporation’s decision in submitting a bid to purchase property that will be sold by a sealed bid. The findings and insights were based on the use of the expected value approach while taking into consideration the risk analyses of the selected recommendations. Comparing the expected values in both cases when market research is employed as well as when it is not employed, the optimum decision recommended would be that which has the highest expected value given the several states of nature (conditions).

Tree Diagram (Refer to Appendix A)


Problem/ Business Context
The problem at hand that Oceanview Development is facing would be making the decision of whether to bid or not to bid for the purchase property. This problem though seemingly simple, is however, made complicated by the many uncertainties that the company faces, such as the likelihood of being the highest bidder, the likelihood of approval of zoning, liquidated damages that have to be paid if Oceanview is to be the highest bidder but fails to obtain approval for zoning, as well as the time factor, all of which would have to be taken into consideration.

As Oceanview has a profit maximizing motive, the decision made should be that which produces the highest expected value when using the expected value approach in resolving this issue. To aid them in their decision making, Oceanview also has the option of hiring a market research firm to conduct a survey that may provide the company with a better estimate of whether zoning for the property will be approved, which may consequently affected their final decision. Decision Strategy, Recommendation and Insights if Market Research is Not Conducted Recommendation

The decision alternatives and states of nature for the analysis are defined as follows: D1 = To bid for the propertyD2 = To not bid for the property S1 = Zoning is approvedS2 = Zoning is not approved

To find out the recommendation that Oceanview should follow if market research is not conducted, the expected value for D1 (at chance node 8) should be calculated and compared with the expected value for D2 before selecting the decision alternative with the higher expected value. The following result was obtained: EV (Node 8) = $0.05 million

As such, given the expected values of the two decision alternatives, with D1 having the higher expected value ($0.05 million), and D2 having an absolute $0 in expected value, the recommendation in line with Oceanview’s profit maximizing motive, would be to proceed with bidding for the property even without market research.

Risk Analysis
To gain insights into the recommended decision, a risk analysis should be used to find out the associated risks. When no market research is conducted, the recommended decision is to bid for the property, with three payoffs resulting from a sequence of branches leading from node 5 to each payoff. Risk analysis will show the risks involved when Oceanview decides to bid for the property.

The first payoff is a profit of $2 million with a probability of 0.06. This means that when Oceanview decides to bid, the probability of zoning being approved given that it is the highest bid is 0.06. The second payoff is a loss of $0.5 million with a probability of 0.14. The third payoff is $0 with a probability of 0.8 of not being the highest bid. Hence, no risk is involved when the bid does not end up being the highest bid, as Oceanview does not make a profit or incur a loss.

Sensitivity Analysis
Next, a sensitivity analysis is conducted to see how changes in the probability of states of natures, S1 and S2, affect the recommended decision alternative, D1. Let p denote the probability of S1, and (1-p) be the probability of S2. With reference to Appendix B,...
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