An entrepreneur is considering building either a large video rental shop or leas
ID: 2648216 • Letter: A
Question
An entrepreneur is considering building either a large video rental shop or lease a small section in a known supermarket. If he gathers market survey information before he make up his mind, the results could suggest either favorable or unfavorable market conditions, but the survey would cost him $30,000 to gather the necessary information. This entrepreneur believes that there is 70% probability chance that the market survey information will be favorable. If the market is favorable, he expects earnings at $150,000 with the large shop, or $50,000 with the leased section. With unfavorable survey information, however, he could loose $20,000 if he builds the large shop, or he would gain net profit of $10,000 for leasing the supermarket section Without a market survey on hand however, he estimates a net profit of $100,000 if he builds a large shop, or $30,000 with a leased supermarket section. What do you recommend this entrepreneur to decide upon in what is concerning taking the survey and investing in?Explanation / Answer
Option - 1
(1) If he gathers market survey information before makes up his mind for build/lease -$30,000
(a) building large video rental shop
Favourable market conditions 0.7 (probability)
Large shop earning $150,000 *0.7 (x) = $105,000
Unfavourable market conditions 0.3 (probability)
Large shop earning -$20,000 *0.3 (y) = $ -6,000
Sub total .................................................. (x+y) $ 99, 000
Total earning $ 69,000
Option-2
(1) If he gathers market survey information before makes up his mind for build/lease -$30,000
(b) Lease small section in super market
Favourable market conditions 0.7 (probability)
Leased section earning $50,000 * 0.7 (t) $35000
Unfavourable market conditions 0.3 (probability)
Leased section earning $10,000 * 0.3 (r) $ 3,000
Sub total .................................................. (t+r) $ 38, 000
Total earning $ 8,000
Option -3
(2) If he does not gather market survey information before makes up his mind for build/lease
(c) Large shop earning $ 100,000
Total Earning $100,000
Option -4
(2) If he does not gather market survey information before makes up his mind for build/lease
(d) Leased section earning $ 30,000
Total Earning $ 30,000
So from above 4 options, Option 3 has highest earning. So entrepreneur should not gather market survey information before makes up his mind and should build a large video rental shop as per option 3.