Decision Tree Analysis

Description

A property owner has an existing complex of ten apartments and is facing an investment decision. The choices are described below: Choice A:   Large Scale Redevelopment This alternative would result in substantial increased revenue but will also require an investment or $1,400,000. Market research reveals that there is a 40% chance that an increased revenue return will be $2,500,000 and a 60% chance that there will be only $800,000 return.   Choice B: Smaller Scale Project Investment This alternative will redecorate the apartment units. It will cost $500,000. Market research reveals that there is a 30% chance of increased revenue or $1,000,000 and a 70% chance of increased revenue of only $500,000.   Choice C: the “As Is” Alternative (the Do Nothing Alternative) This alternative is to continue the existing operation without change. It costs nothing but also produces no increased revenue. The risk is that tenants may become dissatisfied and that it will become more difficult to keep full occupancy.   Assume that the property owner will only choose one of the alternatives. Draw the Decision Tree representing the three choices Add the Choice Nodes showing the market research information Calculate the Expected Values Calculate Net Expected values for each alternative Based on the results from your analysis, which alternative would you recommend to the property owner?

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