What are your recommendations for this sequence of decisions for HDG?
Herndon Development Group (HDG) is planning for a new investment. They would like to make a sequence of decisions that start with determining whether to purchase an apartment building or land. Cost of purchasing an apartment is $800,000 and purchasing land is $200,000.
If HDG purchases the apartment building, two states of nature are possible: The town may exhibit population growth, with a probability of 0.60, or there may be no population growth or a decline, with a probability of .40. If the population grows, the investor will achieve a revenue of $2,000,000. However, if there is no population growth, the revenue is $250,000.
If the decision is to purchase land, the investor will wait for 3 years and consider developing the land based on the population growth. The probability of a growing population is .60, whereas the probability of a stable or declining population is 0.40.
If population growth occurs for a 3-year period, the investor will make another decision regarding land development. At that point, either apartments will be built, at a cost of $800,000, or the land will be sold, with a revenue of $450,000. If the decision after three years is to build apartments, two outcomes are possible: The population may grow, with a conditional probability of 0.80, or there may be no population growth, with a conditional probability of 0.20. The revenues associated with these two states of nature are $3,200,000 and $650,000, respectively.
If no population growth occurs at the end of the 3 years, HDG considers two options: Developing the land commercially at a cost of $600,000, or selling the land for $220,000. If HDG decides to develop the land commercially, then two states of nature can occur. The probability that population growth occurs is 0.30 and the corresponding revenue is $2,200,000. The probability that no population growth occurs is 0.70, and the revenue in this case is $1,100,000.
What are your recommendations for this sequence of decisions for HDG?
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