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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.
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