Homework 3 Solution

# Homework 3 Solution - Spring 2008 UGBA 143 Homework 3...

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Spring 2008, UGBA 143 Homework 3 Solution Problem 1 a) The decision tree for this problem is as follow: Therefore, the best decision is to bid \$1M dollars and the expected payoff for this decision is  \$69,000

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b)  In order to calculate the value of knowing if the “referendum” will pass beforehand, we can  construct a similar tree but with the chance node (pass/fail) moved to the front. It saves a lot of drawing  to recognize that if the referendum fails, no bid will create positive payoff, so the best decision is to  pick “no bid”. If the referendum passes, the best decision is to bid \$1.2M or \$1.5M for a payoff of \$240,000. If the  referendum fails, the payoff is \$0. So the total expected payoff of this process is:   0.65*\$240,000 +  0.35*0 = \$156,000. In order to find the value of information, we can take the difference between the expected pay-off of the  two decision trees: Value of information = \$156,000 - \$69,000 = \$87,000
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