A developer company is considering the purchase of the land for construction of a small shopping center. In order to build that work, the company needs the approval of rezoning of the land by the town. The price of land is $300,000 and the construction of work would require the total investment of $600,000. Once built the company could sell project in $1,360,000.
Costs associated with the process of rezoning of the premises would be $40,000 and anticipates that the probability that the same be approved is only 40%. This process takes approximately 8 to 9 weeks. If the rezoning is not approved, the company is forced to sell the land and achieve a net income of only $260,000.
The company also has the option of acquiring a purchase option for 90 days in the amount of $20,000. During that time you can submit the application for rezoning and wait for the decision of the town before deciding if you buy or not the land. Such amount will not be refunded independent if you are buy or not the land.
The company also has the option of hiring, for fees of $5,000, a consultant that can study the situation and express an opinion about the potential of the rezoning approval. The consultant could predict the rezoning or not. Based on the past experience with this consultant, the company has estimated the following conditional probabilities:
Pr (consultant predicts approval of rezoning | rezoning is approved) = 0.70
Pr (consultant predicts no approval of rezoning | rezoning is not approved) = 0.80
The company has the following options:
a. Do nothing.
b. Buy the land and continue ahead of the rezoning request.
c. Acquire the purchase option, apply for rezoning and wait for the company to decide whether it approves or not rezoning before deciding if buying or not buying the land.
d. Hire the consultant and expect that he sumits his preliminary report before deciding if buy or not buy the land.
Use the decision tree.