International Public Policy and Management Seminar

 

The objective of this lab is to give you continuing experience with simple modeling using Excel spreadsheets.
In addition, the goal is to understand the basics of risk (decision) analysis, including how to draw decision trees,
how to calculate expected monetary value associated with a decision, and how to interpret findings from a decision
analysis.

What is at Issue? Deciding Between Sundowner and Magnifique

You work for Deckard Inc, a development and property management company in the city of San Angeles. Deckard
is deliberating between two potential hotel investment opportunities, which cost essentially the same:

? The first option is to purchase the Suburban Sundowner, a small independently owned chain of motels on the
fringe of several medium sized cities. This investment is virtually without risk, and is expected to return net
revenues of $500,000 per year.

? The alternative is to purchase the Magnifique, a historic luxury hotel on the fringe of the Central Business
District (CBD) of San Angeles. The CBD has been a magnet for homeless individuals and the drug trade, and this has
kept hotel rates low relative to the quality of the hotel. The current room configuration, room rates, and vacancy
rates are shown in Table 1. Note that there are three market segments, “standard, gold, platinum,” each of which has
differing room rates, costs of service, and expected vacancy rates.

The immediate surroundings of the Magnifique are attracting “urban pioneers” from the creative industries,
and a number of cafes and night clubs have opened recently. Deckard believes that the neighborhood is approaching an
economic tipping point, so that a remodeled hotel has the potential to be extremely profitable. Estimates of the
optimal room configuration and pricing with a remodel, under the assumption that the area gentrifies, are in Table 2.
The annualized cost of the remodel is $1,000,000.

Simulation analysis of economic trends suggests that there is a 30 percent chance that the area will
gentrify. There is a 10 percent possibility that the neighborhood will experience an economic slump, increasing
losses. Unfortunately, the decision to remodel will have to be made prior to knowing the economic fate of the
neighborhood.

 

1. Develop a decision tree that represents the decision set facing Deckard Inc. Hint: you need to portray two
choices: (1) Sundowner v. Magnifique and (2) for the Magnifique, remodel or don’t remodel.
a. Draw this out first in pencil—and run it past us to make sure you have it right. The goal of the excel
assignment is to help fill out the payouts.
b. You may, if you wish, turn in your penciled decision tree rather than drawing it out using Word.

2. Using the information in Tables 1 and 2, complete Table 3 which summarizes room revenues and costs for the
choices of remodeling or not remodeling. Note that there are two types of costs: (a) marginal operating costs that
vary with occupancy levels (e.g., utilities; service; cleaning; etc) and (b) fixed costs for staffing and
maintenance.

3. Notice that the financial estimates in Table 3 are based on different economic scenarios. That is, the “no
remodel” financials assume the status quo economy, while the remodel financials assume an optimistic gentrification
scenario. Table 4 shows how much operating costs and revenues will vary under different economic scenarios. Use
this information to complete Table 5, which provides financial estimates for the six potential combinations of
choices and chances.

4. In a Word document, submitted on October 31st, 2012 to the course drop box, interpret your findings for Mr.
Deckard. Address the following:
a. If Deckard, Inc. purchases the Magnifique, should it remodel? Explain and copy Table 5 into the document.
b. Which is the more economically favorable investment, the Sundowner, with certain profits of $500,000 per
year, or the Magnifique, with its element of risk? Explain.
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