Office Building

The management of a bank in the Caribbean was concerned about the potential loss that might occur in the event of a hurricane. The bank estimated that the loss from one of these storms could be as much as $120 million including losses due to interrupted service and customer relations. One project the bank is considering is the installation of an emergency power generator at its operations headquarters.

The cost of the emergency generator is $550,000, and if it is installed no losses from this type of storm will be incurred. However, if the generator is not installed, there is a 10% chance that a power outage will occur during the next year.

If there is an outage there is a 5% probability that the resulting losses will be very large or approximately $135 million in lost earnings. Alternatively it is estimated that there is a 95% probability of only slight losses of around $1.1 million. Using decision tree analysis, determined whether the bank should install the new power generator. (5 pts.)

An investor is to purchase one of three types of real estate. The investor must decide among an apartment building, an office building, and a warehouse. The future states of nature that will determine how much profit the investor will make are good economic conditions and poor economic conditions. The profits that will result from each decision in the event of each state of nature are shown above.

Q-8a. Which investment has the highest EMV and what is the expected value of perfect information in this problem ? Explain your findings so that your non-quantitative partner will understand them. (5 pts.)

      Payoff   Table         Good Economic     Conditions   Decision (Purchase) 50%   Apartment building $80,250    Office   building $125,250   Warehouse $52,750