Reference no: EM13580398

Case Problem: Property Purchase Strategy

Glenn Foreman, president of Oceanview Development Corporation, is considering submitting a bid to purchase property that will be sold by sealed bid at a county tax foreclosure. Glenn's initial judgment is to submit a bid of
$5 million. Based on his experience, Glenn estimates that a bid of $5 million will have a 0.2 probability of being the highest bid and securing the property for Oceanview. The current date is June 1. Sealed bids for the property must be submitted by August 15. The winning bid will be announced on September 1.

If Oceanview submits the highest bid and obtains the property, the firm plans to build and sell a complex of luxury condominiums. However, a complicating factor is that the property is currently zoned for single-family residences only. Glenn believes that a referendum could be placed on the voting ballot in time for the November election. Passage of the referendum would change the zoning of the property and permit construction of the
condominiums.

The sealed-bid procedure requires the bid to be submitted with a certified check for 10% of the amount bid. If the bid is rejected, the deposit is refunded. If the bid is accepted, the deposit is the down payment for the property. However, if the bid is accepted and the bidder does not follow through with the purchase and meet the remainder of the financial obligation within six months, the deposit will be forfeited. In this case, the county will offer the property to the next highest bidder.

To determine whether Oceanview should submit the $5 million bid, Glenn conducted some preliminary analysis. This preliminary work provided an assessment of 0.3 for the probability that the referendum for a zoning change will be approved and resulted in the following estimates of the costs and revenues that will be incurred if the condominiums are built:

Cost and Revenue Estimates:

Revenue from condominium sales $15,000,000
Cost
Property $5,000,000
Construction expenses $8,000,000

If Oceanview obtains the property and the zoning change is rejected in November, Glenn believes that the best option would be for the firm not to complete the purchase of the property. In this case, Oceanview would forfeit the 10% deposit that accompanied the bid.

Because the likelihood that the zoning referendum will be approved is such an important factor in the decision process, Glenn suggested that the firm hire a market research service to conduct a survey of voters. The survey would provide a better estimate of the likelihood that the referendum for a zoning change would be approved. The market research firm that Oceanview Development has worked with in the past has agreed to do the study for $18,000. The results of the study will be available August 1, so that Oceanview will have this information before the August 15 bid deadline. The results of the survey will be either a prediction that the zoning change will be approved or a prediction that the zoning change will be rejected. After considering the record of the market research service in previous studies conducted for Oceanview, Glenn developed the following probability estimates concerning the accuracy of the market research information:

P(A | s1) = 0.75 P(N | s1) = 0.25
P(A | s2) = 0.2 P(N | s2) = 0.8

where

A = prediction of zoning change approval
N = prediction that zoning change will not be approved
s1 = the zoning change is approved by the voters
s2 = the zoning change is rejected by the voters

Managerial Report:

Perform an analysis of the problem facing the Oceanview Development Corporation, and prepare a report that summarizes your findings and recommendations. Include the following items in your report:

1. A decision tree that shows the logical sequence of the decision problem.

2. A recommendation regarding what Oceanview should do if the market research information is not available.

3. A decision strategy that Oceanview should follow if the market research is conducted.

4. A recommendation as to whether Oceanview should employ the market research firm, along with the value of the information provided by the market research firm.

Include all the details of your analysis as an appendix to your report.