Subj: Optimal Cost Strategy for Bill Galen Development (BGD) Company
Bill Galen Development (BGD) Company is seeking the optimal strategy in the purchase and commercial development of a piece of property. Below table is the representation of the given estimations from your company.
It is noteworthy to highlight the existence of the variance application. The reason why it is there because the property is previously a residential one and this variance cost is needed for city council’s approval on developing the area to a commercialized one. Therefore, it is crucial to get it approved or the project will not push through.
The cost analysis would be to draft a decision tree in a tabular format by segregating them using a scenario analysis. The computation and calculation is limited to the assumption that no variable changes will occur during the purchase and the estimated cost and sale are as stipulated in the case.
Analysis and Recommendation
Scenario Analysis
Scenario 1 displayed the highest probable profit the company might acquire given everything goes smoothly. No consultation fee will be shelled out and if the 40% variance application is approved, buying, building, and selling will bebreezed through without any complication. On the other hand, if it will be denied, it would have cost the company, $70,000.
Scenario 2 is different with scenario 1 because of the purchase option. If the company chooses to purchase the 3-month option on variance application extension, the possible profit would be $100,000 and possible loss would be $50,000. Given the same probability of approval (40%) and denial (60%), it would be wiser to not purchase the option.
Scenario 3 represents the calculation when the company avails of a consultant’s opinion. The probability of approval is higher at 70% while denial is lowered to 30%. If the company decides on this, the profit would be $115,000 if approve while $75,000 if denied.
Scenario 4 is similar to scenario 3 except for the additional cost of the purchase option. As mentioned before, it is not advisable to purchase the option due to its added expense and no contribution to profit.
Optimal Strategy
As previously mentioned, the approval of the variance application is very crucial. Therefore, scenario 3 would be the optimal decision to take because even though scenario1 gives the highest payoff, the probability of the consultant’s prediction must also be taken into consideration. Without the assurance of a 70% approval rating from the consultant, scenario 3 would not have been the optimal strategy. The probability of variance application approval in scenario 1 is only 40% which is lower by 30% compared to scenario 3. Even though $5,000 difference is visible, it would still be a better option than be denied (by a probability of 60%) and incur a loss of $70,000.
