Place-Plus, a real estate development firm is considering several alternative development projects. These include building and leasing an office park, purchasing a parcel of land and building an office building to rent, buying and leasing a warehouse, building a strip mall, and building and selling condominiums. The financial success of these projects depends on interest rate movement in the next 5 years. The various development projects and their 5-year financial return (in $1,000,000s) given that interest rates will decline, remain stable, or increase, are shown in the following payoff table. Place-Plus real estate development firm has hired an economist to assign a probability to each direction interest rates may take over the next 5 years. The economist has determined that there is a .50 probability that interest rates will decline, a .40 probability that rates will remain stable, and a .10 probability that rates will increase.
a. Using expected value, determine the best project.
b. Determine the expected value of perfect information.
Project Decline Interest Rate Stable Increase
Office park $0.5 $1.7 $4.5
Office building 1.7 1.9 2.5
Warehouse 1.7 1.4 1.0
Mall 0.7 2.4 3.6
Condominiums 3.2 1.5 0.6