Thom DeBusk, an architect, is considering buying, restoring, and reselling a home in the Draper-Preston historic district of Blacksburg, VA. The cost of the home is $240,000 and Thom believes it can be sold for $450,000 after being restored. Thom expects he can sell the house as soon as the restoration is completed and expects to pay $1,500 a month in finance charges from the time he purchases the house until it is sold. Thom has developed two sets of plans for the restoration. Plan A will cost $125,000 and require 3 months to complete. This plan does not require changes to the front of the house. Plan B is expected to cost $85,000 and require 4 months of work. This plan does involve changes to the front of the house-which will require the approval of the town's historic preservation committee. Thom expects the approval process for plan B to take 2 months and cost about $5,000. Thom thinks there is a 40% chance the historic preservation committee will approve this design. Thom plans to buy the home immediately but cannot decide what he should do next. He could immediately proceed with restoration plan A or he could start immediately with restoration plan B. Of course, if he starts immediately with plan B, he will not know for 2 months whether the historic preservation committee approves of this plan. If they do not approve it, he will have to start over and implement plan A instead. Starting over with plan A would cost an additional $20,000 over plan A's normal cost and add an additional month to plan A's normal completion schedule. Alternatively, Thom can hold off implementing either plan until he knows the outcome of the historic planning committee's decision. a. Create a decision tree for this problem. b. What set of decisions should Thom make if he follows the maximum EMV criterion?
Thom DeBusk, an architect, is considering buying, restoring, and reselling a home in the Draper-Preston historic district of Blacksburg, VA. The cost of the home is $240,000 and Thom believes it can be sold for $450,000 after being restored. Thom expects he can sell the house as soon as the restoration is completed and expects to pay $1,500 a month in finance charges from the time he purchases the house until it is sold. Thom has developed two sets of plans for the restoration. Plan A will cost $125,000 and require 3 months to complete. This plan does not require changes to the front of the house. Plan B is expected to cost $85,000 and require 4 months of work. This plan does involve changes to the front of the house-which will require the approval of the town's historic preservation committee. Thom expects the approval process for plan B to take 2 months and cost about $5,000. Thom thinks there is a 40% chance the historic preservation committee will approve this design. Thom plans to buy the home immediately but cannot decide what he should do next. He could immediately proceed with restoration plan A or he could start immediately with restoration plan B. Of course, if he starts immediately with plan B, he will not know for 2 months whether the historic preservation committee approves of this plan. If they do not approve it, he will have to start over and implement plan A instead. Starting over with plan A would cost an additional $20,000 over plan A's normal cost and add an additional month to plan A's normal completion schedule. Alternatively, Thom can hold off implementing either plan until he knows the outcome of the historic planning committee's decision. a. Create a decision tree for this problem. b. What set of decisions should Thom make if he follows the maximum EMV criterion?
Chapter1: Financial Statements And Business Decisions
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Transcribed Image Text:27. Thom DeBusk, an architect, is considering buying, restoring, and reselling a home in
the Draper-Preston historic district of Blacksburg, VA. The cost of the home is
$240,000 and Thom believes it can be sold for $450,000 after being restored. Thom
expects he can sell the house as soon as the restoration is completed and expects to
pay $1,500 a month in finance charges from the time he purchases the house until it is
sold. Thom has developed two sets of plans for the restoration. Plan A will cost
$125,000 and require 3 months to complete. This plan does not require changes to the
front of the house. Plan B is expected to cost $85,000 and require 4 months of work.
This plan does involve changes to the front of the house-which will require the
approval of the town's historic preservation committee. Thom expects the approval
process for plan B to take 2 months and cost about $5,000. Thom thinks there is a 40%
chance the historic preservation committee will approve this design. Thom plans to
buy the home immediately but cannot decide what he should do next. He could
immediately proceed with restoration plan A or he could start immediately with
restoration plan B. Of course, if he starts immediately with plan B, he will not know
for 2 months whether the historic preservation committee approves of this plan. If
they do not approve it, he will have to start over and implement plan A instead.
Starting over with plan A would cost an additional $20,000 over plan A's normal cost
and add an additional month to plan A's normal completion schedule. Alternatively,
Thom can hold off implementing either plan until he knows the outcome of the
historic planning committee's decision.
a. Create a decision tree for this problem.
b. What set of decisions should Thom make if he follows the maximum EMV
criterion?
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