The lease of Theme Park, Inc., is about to expire. Management must decide whethe
ID: 395211 • Letter: T
Question
The lease of Theme Park, Inc., is about to expire. Management must decide whether to renew the lease for another 10 years or to relocate near the site of a proposed motel. The town planning board is currently debating the merits of granting approval to the motel. A consultant has estimated the net present value of Theme Park’s two alternatives under each state of nature as shown below. Suppose that the management of Theme Park, Inc., has decided that there is a 0.41 probability that the motel’s application will be approved.
a-1.
If management uses maximum expected monetary value as the decision criterion, calculate expected monetary value for the alternatives "Renew" and "Relocate"? (Omit the "$" sign in your response.)
a-2. Which alternative should it choose?
c. If management has been offered the option of a temporary lease while the town planning board considers the motel’s application, would you advise management to sign the lease? The lease will cost $41,000. (Omit the "$" sign in your response.)
Motel Approved Motel Rejected Options Renew Relocate $ 610,e00 $4,525,00e 310,000 2,525,000Explanation / Answer
a-1) EMV from renew = .41*610000 + .59*4525000 = 2919850
EMV from relocate = .41*2525000 + .59*310000 = 1218150
a-2) Hence Renew lease should be selected.
c) EVPI = EV with perfect information – EV maximum
= EV with perfect information = .41*2525000 + .59*4525000
= 3705000
EVPI = 3705000 – 2919850 = 785150
Yes as the cost is less than EVPI of 785150 $
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