Page 138, Number 6

6. A builder has located a piece of property that she would like to buy and eventually
build on. The land is currently zoned for 4 homes per acre, but she is planning to
request new zoning. What she builds depends on approval of the zoning request
and your analysis of this problem to advise her. With her input and your help the
decision process has been reduced to the following costs, alternatives and
probabilities:
i. Cost of land: 2 mill USD
ii. Probability of rezoning: 60%
iii. If rezoned, an additional cost of 1 mill USD
b. If the land is rezoned the contractor must decide whether to build a shopping
center or 1.500 apartments.
i. If she builds a shopping center she estimates 70% chance that she can
sell it to a large department chain for 4 mill USD over her construction
cost (which excludes the cost of land), and she estimates 30% chance
that she can sell it to an insurance company for 5 mill USD over
construction cost.
ii. If instead of the shopping center she decides to build the 1.500
apartments she places probabilities on her profit as follows: 60%
chance that she can sell the apartments for 3.000 USD each over
construction cost and 40% that she gets only 2.000 USD for each
apartment.
c. If the land is not rezoned she can only build 600 homes on which she expects
to make 4.000 USD each over construction cost (as before excluding cost of
land).

Draw a decision tree of this problem and determine the best solution and the expected
net profit.
Department Chain 0.7
Shopping Center
Insurance Company 0.3

Rezoned
3,000 per Apartment 0.6
0.6 1,500 Apartments
Builder 2,000 per Apartment 0.4

Not Rezoned

0.4

Alternative Revenue Cost Value

Rezoned, Shopping Center, Large Department Chain 4 3 1
Rezoned, Shopping Center, Insurance Company 5 3 2
Rezoned, Apartments, Sold at 3k per apartment 4.5 3 1.5
Rezoned, Apartments, Sold at 2k per apartment 3 3 0
Not Rezoned 2.4 2 0.4

Rezoned shopping center = $4.3 million.

Rezoned apartments = $3.9 million.
No rezoning = $0.4 million.
Expected results: .60(1.3) + 0.40(0.4) = $0.94 million.