Question

SGC PROPERTIES

Chris Lucarelli, president of SGC Properties, is considering submitting a bid to purchase property that will be sold by sealed bid at a county tax foreclosure. Chris’ initial judgment is to submit a $5 million. Based on his experience, Chris estimates that a bid of $5 million will have a 0.2 probability of being the highest bid and securing the property for SGC. The current date is July 1. Sealed bids for the property must be submitted by September 15. The winning bid will be announced on October 1.

If SGC submits the highest bid and obtains the property, the firm plans to build and sell a complex of luxury condominiums. However, a complicating factor is that the property is currently zoned for single-family residences only. Chris believes that a referendum cold be placed on the voting ballot in time for the November election. Passage of the referendum would change the zoning of the property and permit construction of the condominiums.

The sealed-bid procedure requires the bid to be submitted with a certified check for 10% of the amount of the bid. If the bid is rejected, the deposit is refunded. If the bid is accepted, the deposit is the down payment for the property. However, if the bid is accepted and the bidder does not follow through with the purchase and meet the remainder of the financial obligation within six months, the deposit will be forfeited. In this case, the county will offer the property to the next highest bidder.

To determine whether SGC should submit the $5 million bid, Chris conducted some preliminary analysis. The preliminary work provided an assessment of 0.3 for the probability that the referendum for a zoning change will be approved and resulted in the following estimates of the cost and revenues that will be incurred if the condominiums are built:

Cost and Revenue Estimates

Revenue from condominium sales

$15,000,000

Cost

Property

$5,000,000

Construction expenses

$8,000,000

If SGC obtains the property and the zoning change is rejected in November, Chris believes that the best option would be the firm not to complete the purchase of the property. In that case, SGC would forfeit the %10 deposit that accompanied the bid.

Because the likelihood that the zoning referendum will be approved is such an important factor in the decision process, Chris suggested that the firm hire a market research service to conduct a survey of voters. The survey would provide a better estimate of the likelihood that the referendum for a zoning change would be approved. The market research firm the SGC has worked with in the past has agreed to do the study for $15,000. The results of the study will be available September 1, so that SGC will have the information before the September 15 bid deadline. The results of the survey will be either a prediction that the zoning change will be approved or a prediction that the zoning change will be rejected. After considering the record of the market research service in previous studies conducted for SGC, Chris developed the following probability estimates concerning the accuracy of the market research information:

where

​A = prediction of zoning change approved

​N = prediction of zoning change will not be approved

s1 = the zoning change is approved by voters

s2 = the zoning change is rejected by voters

Perform an analysis of the problem facing SGC Properties, and prepare a report with your recommendations. Make the sure the following questions are addressed.

1. What should SGC do If they do not have the market research information?

2. What should SGC do it they have the market research information?

3. Should SGC hire the market research firm? What is the value of the information?

Answer 1

a) If SGC does not have market research information:

SGC has only 0. 2 probability or 20% chance that their bid will be the highest bid. Even the preliminary analysis work provided that there is only 30% chance that the referendum for a zoning change will be approved. If the zoning change is rejected, as per Chris's belief he would not go ahead with the purchase plan in which case he will incur a loss of $ 500,000 which is 10% of the bid amount i.e. $ 5 million. Considering the low probability of winning the bid, and low probabilit for getting the zonal change referrendum approved along with loss of forfeiting 10% of the bid amount if the purchase plan is cancelled, the best course of actionfor SGC is to not to go ahead with submission of the bid.

2) If SGC has market information:

Market research service is hired to provide the probability for the zonal change approval. The cost of market research is $ 15,000. But the information given in the question does not mention what is the probability that the zonal change approval will be voted by the voters. Presuming that the market research survey report also predicts a low probability for getting the zonal change approval, the hiring of the services will result in additional cost of $ 15,000. Therefore SGC should not go ahead with submission of bid, in general.

But based on Cris's probability estimates, if the survey result is AxS1 is greater than 0.5, it indicates that there is more than 50% chance for getting the zonal change approval. Eventhen, since the probability of his bid being highest is only 20%, he should not go ahead with submission of the bid.

3) SGC should not hire the market research firm. This is because even if the results of the market survey indicates highest probability for getting the approval for zonal change the probability of Chris's bid being highest is very low.

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