2013

PROPERTY PURCHASE STRATEGY

Subject: Quantitative Techniques III Professor: Prof. Bhavin J. Shah Group No: 3 Date: 6th March, 2013 IIM Indore PGP Mumbai Batch of 2014

Prepared By: Ankur Sinha (03) Arvind Kumar (05) Gunreet Kaur Thind (11) Karri Kartik (14) Pradyoth C John (23) Sandeep Sayal (28) Abhijeet Panwar (35)

Table of Contents
1. INTRODUCTION........................................................................................................ 3 1.1 Situation Analysis3 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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Property Purchase Strategy Analysis

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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 Dont go for the market survey Dont bid for the property

2.2 Decision Tree

Without Survey
0.2 Bid Successful 0 Submit bid 0 -500000 50000 0.8 Bid Unsuccessful 1 50000 500000 0 0 -500000 250000 0.3 Zone Change reg. passed 1 0 2000000 0.7 Zone Change reg. not passed -500000 Revenue Generated 2000000 2500000 2000000

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 Dont 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 Dont 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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Property Purchase Strategy Analysis

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