Module 3 – SLP
LINEAR REGRESSION FORECASTING AND DECISION TREES
Decision Trees
Scenario: You are a consultant who works for the Excellent
Consulting Group. You have learned about three different investment
opportunities and need to decide which one is most lucrative. Following are the
three investment options and their probabilities:
Option A: Real Estate development. This is a risky
opportunity with the possibility of a high payoff, but also with no payoff at
all. You have reviewed all of the possible data for the outcomes in the next 10
years and these are your estimates of the cash payoff and probabilities:
Required initial investment: $0.85 million
High NPV: $6 million, Pr = 0.50
Medium NPV: $2.5 million, Pr = 0.35
Low NPV: $0, Pr = 0.15
Option B: Retail franchise for Just Hats, a boutique-type
store selling fashion hats for men and women. This also is a risky opportunity
but less so than Option A. It has the potential for less risk of failure but
also a lower payoff. You have reviewed all of the possible data for the
outcomes in the next 10 years and these are your estimates of the payoffs and
probabilities.
Required initial investment: $0.50 million
High NPV: $3.5 million, Pr = 0.70
Medium NPV: $2.1 million, Pr = 0.20
Low NPV: $1 million, Pr = 0.10
Option C: High Yield Municipal Bonds. This option has low
risk and is assumed to be a Certainty. So there is only one outcome with
probability of 1.0:
Required initial investment: $0.65 million
NPV: $1.7 million, Pr = 1.0
Assignment
Develop an analysis of these three investments, and
determine which of them you should choose. Be sure to account for cash paid for
each of the three alternatives. If you do not recall how to do this, review the
practice exercises at the Background page. Do your analysis in Excel using the
Decision Tree add-in.
Write a report to your private investment company and
explain your analysis and your recommendations. Provide a rationale for your
decision.
Upload both your written report and Excel file with the decision
tree analysis to the SLP 3 Dropbox.
SLP Assignment Expectations
Analysis
Accurate and complete Excel analysis.
Written Report
Length requirements: 2–3 pages minimum (not including Cover
and Reference pages)
Provide a brief introduction to/ background of the problem.
Written analysis that supports Excel analysis and provides
thorough discussion of assumptions, rationale, and logic used.
Complete, meaningful, and accurate recommendation(s).
