A builder has located a piece of property that she would like to buy and eventually build on. The land is currently zoned for four homes per acre, but she is planning to request new zoning. What she builds depends on approval of zoning requests and your analysis of this problem to advise her. With her input and your help, the decision process has been reduced to the following costs, alternatives, and probabilities: Cost of land: $2 million.
Probability of rezoning: 0.40.
If the land is rezoned, there will be additional costs for new roads, lighting, and so on, of $1 million.
If the land is rezoned, the contractor must decide whether to build a shopping center or 1,500 apartments that the tentative plan shows would be possible. If she builds a shopping center, there is a 70 percent chance that she can sell the shopping center to a large department store chain for $6 million over her construction cost, which excludes the land; and there is a 30 percent chance that she can sell it to an insurance company for $4 million over her construction cost (also excluding the land). If, instead of the shopping center, she decides to build the 1,500 apartments, she places probabilities on the profits as follows: There is a 40 percent chance that she can sell the apartments to a real estate investment corporation for $3,100 each over her construction cost; there is a 60 percent chance that she can get only $2,520 each over her construction cost. (Both exclude the land cost.)
If the land is not rezoned, she will comply with the existing zoning restrictions and simply build 500 homes, on which she expects to make $3,500 over the construction cost on each one (excluding the cost of land).
a. What is the expected value for the rezoned shopping center?
b. What is the expected value for the rezoned apartments?
c. What is the expected profit, if the land is not rezoned?
d. What is the expected net profit?