Interest Rate Project Decline Stable Increase Office Park € 0.5 € 1.7 € 4.5 Office building 1.5 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
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 image of the payoff table:
(a) Determine the best investment, using the following decision criteria: Maximax, Maximin, Equal likelihood, Hurwicz (alpha=30%)
(b) Place-Plus 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. Determine the expected value of perfect information.
(c) Place-Plus is dissatisfied with the economist’s estimate of the probabilities of future interest rate movement, so it is considering having a financial consulting firm provide a report on future interest rates. The consulting firm can cite a track record which shows that 80% of the time when interest rates declined, it had predicted they would, whereas 10% of the time when interest rates declined, the firm had predicted they would remain stable and 10% of the time it had predicted they would increase. The firm has been correct 70% of the time when rates have remained stable, whereas 10% of the time it has incorrectly predicted that rates would decrease, and 20% of the time it has incorrectly predicted that rates would increase. The firm has correctly predicted that interest rates would increase 90% of the time and incorrectly predicted rates would decrease 2% and remain stable 8% of the time. If the consulting firm could supply an accurate report, determine how much PlacePlus should be willing to pay the consulting firm and how efficient the information will be.
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