Decision Tree and Value of Information, business and finance homework help

User Generated

YnjlreTvey

Business Finance

Description

Scenario: You are deciding among three investments, as you do for Case 4. You have heard of an expert who has a highly reliable “track record” in the correct identification of favorable vs. unfavorable market conditions. You are now considering whether to consult this “expert.” Therefore, you need to determine whether it would be worth paying the expert’s fee to get his prediction. You recognize that you need to do further analysis to determine the value of the information that the expert might provide.

In order to simplify the analysis, you have decided to look at two possible outcomes for each alternative (instead of three). You are interested in whether the market will be Favorable or Unfavorable, so you have collapsed the Medium and Low outcomes. Here are the three alternatives with their respective payoffs and probabilities.

Option A: Real estate development. This is a risky opportunity with the possibility of a high payoff, but also with no payoff at all. You have reviewed all of the possible data for the outcomes in the next 10 years and these are your estimates of the Net Present Value (NPV) of the payoffs and probabilities:

High/Favorable NPV: $7.5 million, Pr = 0.5

Unfavorable NPV: $2.0 million, Pr = 0.5

Option B: Retail franchise for Just Hats, a boutique-type store selling fashion hats for men and women. This also is a risky opportunity but less so than Option A. It has the potential for less risk of failure, but also a lower payoff. You have reviewed all of the possible data for the outcomes in the next 10 years and these are your estimates of the NPV of the payoffs and probabilities.

High/Favorable NPV: $4.5 million, Pr = 0.75

Unfavorable NPV: $2.5 million, Pr = 0.25

Option C: High Yield Municipal Bonds. This option has low risk and is assumed to be a Certainty. So there is only one outcome with probability of 1.0:

NPV: $2.25 million, Pr = 1.0

You have contacted the expert and received a letter stating his track record which you have checked out using several resources. Here is his stated track record:

True State of the Market

Expert Prediction

Favorable

Unfavorable

Predicts “Favorable”

.9

.3

Predicts “Unfavorable”

.1

.7

You realize that this situation is a bit complicated since it requires the expert to analyze and predict the state of two different markets: the real estate market and the retail hat market. You think through the issues of probabilities and how to calculate the joint probabilities of both markets going up, both going down, or one up and the other down. Based on your original estimates of success, here are your calculations of the single probabilities and joint probabilities of the markets.

Probabilities

Favorable

Unfavorable

A: Real Estate

0.50

0.50

B: Just Hats

0.75

0.25

Joint Probabilities

A Fav, B Fav (A+, B+)

0.375

A Unf, B Unf (A-, B-)

0.125

A Fav, B Unf (A+, B-)

0.125

A Unf, B Fav (A-, B+)

0.375

Finally, after a great deal of analysis and calculation, you have determined the Posterior probabilities of Favorable and Unfavorable Markets for the Real Estate business and the boutique hat business.

Real Estate

Just Hats

F

U

F

U

0.45

says "F/F"

0.75

0.25

0.90

0.10

0.15

says "F/U"

0.75

0.25

0.30

0.70

0.30

says "U/F"

0.125

0.875

0.90

0.10

0.10

says "U/U"

0.125

0.875

0.30

0.70

For example, this table says that there is 45% chance that the expert will predict Favorable for both markets (F/F), and when he makes this prediction, there is a 75% chance that the Real Estate market will be favorable and 25% chance that it won’t, and also a 90% chance that the Hat market will be Favorable and 10% chance it won’t.

You have developed a Decision Tree showing the original collapsed solution and also showing an expanded Decision Tree for evaluating the value of the expert’s information. You need to enter the probabilities into this tree to see if the expert’s information will increase the overall expected value of your decision. Download the Excel file with the incomplete Decision Tree: Decision Tree for BUS520 SLP 4

Assignment

Complete the information in the Decision Tree in the Excel file. Determine the Expected NPV of the decision if you were to consult the Expert. Does use of the Expert increase the value of your analysis? If so, by how much?

Develop a PowerPoint presentation to your private investment company and explain your analysis and your recommendation. Provide clear rationale/ justification for your decision. Use audio/video feature in PowerPoint to present each slide. Be sure to check the Oral Communication Rubric (under Assessments>Rubrics) to understand the requirements for the PowerPoint presentation.

Upload both your PowerPoint presentation and Excel file with the Decision Tree analysis to the SLP 4 Dropbox.

SLP Assignment Expectations

Analysis

Conduct accurate and complete analysis in Excel. Check the following link on PowerPoint presentation:

https://support.office.com/en-US/article/PowerPoin...

Required:

  • Meet Length requirements: 10-15 slides (not including Cover and Reference pages).
  • Provide a brief introduction to/background of the problem.
  • Show analysis that supports Excel analysis and provides thorough discussion of assumptions, rationale, and logic used.
  • Offer meaningful and accurate recommendation(s).
  • Oral presentation of each slide should use video/audio feature in PowerPoint

Unformatted Attachment Preview

Value Measure U-Value 0.5 High/Favorable 7.5 7.5 2 2 4.5 4.5 2.5 2.5 2.25 2.25 >>> A-Real Estate 4.75 4.75 0.5 UNFAVORABLE 0.75 High/Favorable B-Just Hats 4.75 4.75 4 4 0.25 UNFAVORABLE 10 year Bond 0.5 Favorable >>> A-Real Estate 4.75 4.75 0.5 Unfavorable 0.75 Favorable B-Just Hats 4 4 0.25 Unfavorable 10 year Bond 0 Exp says "F/F" 2.25 2.25 4.75 4.75 >>> 0 Exp says "U/U" 2.25 2.25 >>> Consult Expert 0 0 0 Exp says "F/U" 2.25 2.25 >>> 0 Exp says "U/F" 2.25 2.25 >>> Value Measure U-Value 7.5 7.5 2 2 4.5 4.5 2.5 2.5 Use the probabilities from the Table tree. The cells that need probability 2.25 2.25 Once you have correctly updated the you will be able to see the Expected Expert's predictions. 0 Favorable 7.5 7.5 Real Estate 0 0 0 Unfav 2 2 0 Favorable 4.5 4.5 2.5 2.5 Keep in mind that you have not cons simply performing an analysis based prior estimates of the probabilities o markets. You want to see if consultin additional value to your decision. Be sure to write your report and incl Upload your report and this Excel file Just Hats 0 0 0 Unfav. Bond 2.25 2.25 Expert's Prediction Prob. 0.45 0.15 0.30 0 Fav 0.10 7.5 7.5 2 2 4.5 4.5 2.5 2.5 2.25 2.25 7.5 7.5 2 2 4.5 4.5 2.5 2.5 2.25 2.25 7.5 7.5 2 2 Real Estate 0 0 0 Unf 0 Fav Just Hats 0 0 0 Unf Bond 0 Fav Real Estate 0 0 0 Unf 0 Fav Just Hats 0 0 0 Unf Bond 0 Fav Real Estate 0 0 0 Unf 0 Fav 4.5 4.5 2.5 2.5 2.25 2.25 Just Hats 0 0 0 Unf Bond e probabilities from the Table below and fill in this decision he cells that need probability values are highlighted in green. you have correctly updated the d-tree with the probabilities, ll be able to see the Expected NPV of this analysis with the 's predictions. n mind that you have not consulted the Expert yet, you are performing an analysis based on his track record and your stimates of the probabilities of Favorable or Unfavorable ts. You want to see if consulting this expert will provide onal value to your decision. e to write your report and include the results of this analysis. d your report and this Excel file to SLP4 Dropbox. pert's Prediction Prediction says "F/F" says "F/U" says "U/F" Posterior Probabilities of Market States Real Estate Just Hats F U F U 0.750 0.250 0.900 0.100 0.750 0.250 0.300 0.700 0.125 0.875 0.900 0.100 says "U/U" 0.125 0.875 0.300 0.700
Purchase answer to see full attachment
User generated content is uploaded by users for the purposes of learning and should be used following Studypool's honor code & terms of service.

Explanation & Answer

Find the attached document,Slides optionsThank you so much

Value
Measure U-Value

0.5 High/Favorable
7.5

7.5

2

2

4.5

4.5

2.5

2.5

2.25

2.25

>>> A-Real Estate
4.75

4.75

0.5 UNFAVORABLE

0.75 High/Favorable
B-Just Hats
4.75
4.75

4

4

0.25 UNFAVORABLE

10 year Bond

0.5 Favorable
A-Real Estate
4.75

4.75

0.5 Unfavorable

0.75 Favorable
B-Just Hats
4

4

0.25 Unfavorable

10 year Bond

>>>

6.125
4.3
12.68 Exp says "F/F"
6.125
11.27563
11.27563

6.125

2.688
3.1
8.038 Exp says "U/U"
>>>
3.1

3.1

>>> Consult Expert
11.2756

11.27563
>>>

6.125
3.1
11.48 Exp says "F/U"
6.125

6.125

2.688
4.3
9.238 Exp says "U/F"
>>>
4.3

4.3

Value
Measure U-Value

7.5

7.5

2

2

4.5

4.5

2.5

2.5

Use the probabilities from the Table
tree. The cells that need probability
2.25

2.25

Once you have correctly updated the
you will be able to see the Expected
Expert's predictions.

0.75 Favorable
7.5

7.5

Real Estate
6.125

6.125

0.25 Unfav
2

2

4.5

4.5

2.5

2.5

0.9 Favorable

Keep in mind that you have not cons
simply performing an analysis based
prior estimates of the probabilities o
markets. You want to see if consultin
additional value to your decision.

Be sure to write your report and incl
Upload your report and this Excel file

Just Hats
4.3

4.3

0.1 Unfav.

Bond
2.25

2.25

Expert's Prediction
Prob.
0.45
0.15
0.30

0.13 Fav

0.10
7.5

7.5

2

2

4.5

4.5

2.5

2.5

2.25

2.25

7.5

7.5

2

2

4.5

4.5

2.5

2.5

2.25

2.25

7.5

7.5

2

2

Real Estate
2.6875

2.6875

0.88 Unf

0.3 Fav
Just Hats
3.1

3.1

0.7 Unf

Bond

0.75 Fav
Real Estate
6.125

6.125

0.25 Unf

0.3 Fav
Just Hats
3.1

3.1

0.7 Unf

Bond

0.13 Fav
Real Estate
2.6875

2.6875

0.88 Unf

0.9 Fav
4.5

4.5

2.5

2.5

2.25

2.25

Just Hats
4.3

4.3

0.1 Unf

Bond

e probabilities from the Table below and fill in this decision
he cells that need probability values are highlighted in green.

you have correctly updated the d-tree with the probabilities,
ll be able to see the Expected NPV of this analysis with the
's predictions.

n mind that you have not consulted the Expert yet, you are
performing an analysis based on his track record and your
stimates of the probabilities of Favorable or Unfavorable
ts. You want to see if consulting this expert will provide
onal value to your decision.

e to write your report and include the results of this analysis.
d your report and this Excel file to SLP4 Dropbox.

pert's Prediction
Prediction
says "F/F"
says "F/U"
says "U/F"

Posterior Probabilities of Market States
Rea...


Anonymous
This is great! Exactly what I wanted.

Studypool
4.7
Trustpilot
4.5
Sitejabber
4.4

Similar Content

Related Tags