2013

PROPERTY PURCHASE STRATEGY

Subject: Quantitative Techniques III

Professor: Prof. Bhavin J. Shah

Prepared By:
Group No: 3 Ankur Sinha (03)
Date: 6th March, 2013 Arvind Kumar (05)
Gunreet Kaur Thind (11)
IIM Indore PGP Mumbai Karri Kartik (14)
Batch of 2014 Pradyoth C John (23)
Sandeep Sayal (28)
Abhijeet Panwar (35)
 Table of Contents

1. INTRODUCTION........................................................................................................ 3
1.1 Situation Analysis………………………………………………………………………………………………………3
1.2 Objective……………………………………………………………………………..……………………………………3
1.3 Problem Statement………………………………………………………………..…………………………………3

2. ANALYSIS ................................................................................................................... 4
2.1 Alternate course of action ............................................................................................. 4
2.2 Decision Tree.................................................................................................................. 4
2.3 EMV without information– Solving the decision tree ................................................... 5
2.4 EMV with information and Cost of Information ............................................................ 5

3. CONCLUSION & RECOMMENDATION .............................................................. 6

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 1. INTRODUCTION

1.1SITUATION ANALYSIS – RELEVANT CASE FACTS

 Oceanview Development Corporation wants to bid $5 Million (Highest bid probability of
0.2) to purchase a property
 .It plans to build and sell a complex of luxury condominiums but the property is currently
zoned for single family residences
 Revenue = $15,000,000 and Costs = $5,000,000 (Property) + $ 8,000,000 (Construction)
 Passage of a referendum (Probability of 0.3) would change the zoning of the property in
favour of Oceanview
 Bid has to be submitted along with a certified checkfor 10% of bid amount
 If bid gets rejected, this 10% will get refunded
 If bid gets accepted, this 10% will act as a down payment for the property
 If bid gets accepted and the bidder fails to follow up, this 10% will be forfeited
 If bid gets accepted and the zoning change is rejected, the best option would be to forfeit
this 10% and not purchase the property
 Market research service can be hired for $ 15,000 to predict whether the zoning change
will be approved or rejected
 The market research information might not be completely accurate
 Probability of prediction of approval when actually approved = 0.9
 Probability of prediction of rejection when actually approved = 0.1
 Probability of prediction of rejection when actually rejected = 0.8
 Probability of prediction of approval when actually rejected = 0.2

1.2 OBJECTIVE
To maximise the revenue (Expected monetary value) either by investing in property or not.

1.3 PROBLEM STATEMENT

To decide whether or not to bid for the property because of the uncertainty associated with
the outcome of the bid and also with the approval/disapproval of the referendum.

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 2. ANALYSIS
2.1 Alternate course of Action
 Bid for the property
 Go for the market survey
 Don’t go for the market survey
 Don’t bid for the property

2.2 Decision Tree

Without Survey
0.3
Zone Change reg. passed Revenue Generated
0.2 1 2000000
Bid Successful 0 2000000 2500000 2000000

0 250000 0.7
Zone Change reg. not passed
Submit bid -500000
0 -500000
-500000 50000
0.8
Bid Unsuccessful
1 0
50000 500000 0

Don't Submit
0
0 0

Calculating Posterior Probabilities

As prior probabilities are given, we will have to calculate posterior probabilities and then
take decision accordingly.

This tree shows the prior probabilities associated (as given in the case)

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After calculating the posterior probabilities the new tree becomes as shown below:

The final decision tree with survey is shown below:

With Survey

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2.3 Expected Monetary Value without Survey– Solving the Decision Tree

EMV of successful bid and passing of zone change referendum = $20,00,000

EMV of successful bid and failure of zone change referendum= - $ 5,00,000
EMV of successful bid = 0.3*20,00,000 + 0.7 * (-5,00,000) = $2,50,000
EMV of unsuccessful bid = $5,00,000-$5,00,000 = $0
Submit the bid EMV = 0.8*0+0.2*2,50,000 = $50,000
Don’t submit bid, EMV = $0
Hence EMV of decision tree = $ 50,000 (i.e. Submit the Bid)

2.4 Cost of Information - Solving the Decision Tree

EMV with market research information
Suppose we go for the market research information.
The upfront research cost is $15,000

As the information is not perfect, we calculate the probability of passing of the zone change
referendum to be 0.25 and probability of failure of the zone change referendum to be 0.75.

We calculate the posterior probabilities: (as shown in the tree above)

Probability that survey says that zone will be changed = 0.41
Probability that survey says that zone will not be changed=0.59
Probability that zone is actually changed after the survey reports that it will be changed
=0.658
Probability that zone is actually not changed after the survey reports that it will be not
changed= 0.95

Payoff in case of successful bid and passing of zone change referendum = $1,985,000
Payoff in case of unsuccessful bid and passing of zone change referendum = - $15,000
Payoff in case of successful bid and not passing of zone change referendum=-$ 515,000

Solving the decision tree we get,

EMV without market research information = $50,000
And EMV with market research information = $78,890
Therefore, Cost of information = $ (78,890-50,000) = $ 28,890

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 3. CONCLUSION & RECOMMENDATION
Without Market Research information
Submit the bid EMV = 0.8*0+0.2*2,50,000 = $50,000
Don’t submit bid, EMV = $0
Hence, if market research information is not available, Oceanview should submit the bid as
the EMV of submitting the bid ($50,000) is more than that of not submitting the bid ($0)

With Market Research information

Submit the bid EMV with information = $78,890
Hence if information about the success/failure of the zone change referendum is known,
Oceanview should submit the bid as it has a EMV of $78,890 as compared to an EMV of -$
15,000 of not bidding after information.

Cost of Information
EMV without market research information = $50,000
EMV with market research information = $ 78,890
Cost of information = $ (85,750-50,000) = $ 28,890
Hence Oceanview should pay a maximum amount of $ 28,890 for the market research
information.

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