After successfully having navigated the LPP issue, HCFP has once again for your help. Now, they are considering implementing a new drainage system to improve water flow across the various ponds within their property. They have found that poor drainage yields significant bacteria build-up that negatively affects both the ecosystems within and human visitors to their preserves. You have found the following:
- The new drainage system has an 80% chance of working well and a 20% chance of not working well
- A new drainage system that works well will yield $150,000 in benefit to HCFP
- A new drainage system that does not work well will yield only $40,000 in benefit to HCFP
- Not installing the new system (that is, keeping the status quo) provides $100,000 in benefit to HCFP
- A test of the drainage system costs $15,000; this test will tell them with absolute certainty whether the system will work well.
Assume all costs and benefits above are expressed in present values.
a. If HCFP's goal is to maximize the expected net benefit, should they test the system? Be sure to draw the decision tree that supports your answer.
b. Assume for this part only that installing a drainage system that does not work well has a benefit of $0, instead of $40,000.Should HCFP test the drainage system? What is the most that HCFP should be willing to pay for the test?