Question

ou are considering buying a $300,000 house. Because it is older, there is a 20% chance the house has serious structural problems and it would need to be torn down leaving you with only the lot value ($30,000). Otherwise it will be worth the asking price. You need to pay a $10,000 deposit to get it inspected. There is a 10% chance the inspection will find problems if they exist. Or you can pay $5,000 more for a premium inspection which has a 30% chance of finding problems. If any problems are found you will get your $10,000 deposit back.

1. Draw a complete decision tree for the problem as stated showing the value of each outcome as well as the best decision to make in each case.

2. Now, building on the decision tree above, suppose that you had to buy a house but you were given a choice of 3 homes, one at the top end of your budget ($800k), one in the middle ($500k), and the current choice. Each house has a chance of serious defects but the same lot value. However the middle and upper houses have a lower chance of the inspection finding anything because the paint is new (standard inspection 5% premium 20%). Show the expanded decision tree with outcomes and decision values.

3. Finally, suppose that you have a chance that a new slaughterhouse will be built near your home which would cut the value down by $100k. The odds of this would be different for each house. What is the minimum chance of this happening that would make the house choices have equal value? Show the expanded tree and decision values along with your answer

Answer 1

Answer:

7000 and fixed

Explanation: