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1.1westhouser Paper

Westhouser Paper Company is considering purchasing a piece of land for $2.2 million that has timber they need in July. There is a risk another company could buy it before then, with a 1 in 20 chance in May and 1 in 10 chance in June. The land price may decrease in May and June, with probabilities listed in the tables. If purchased, Westhouser expects $3 million profit from the land, but $650k from alternative investments if not purchased.

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83 views1 page

1.1westhouser Paper

Westhouser Paper Company is considering purchasing a piece of land for $2.2 million that has timber they need in July. There is a risk another company could buy it before then, with a 1 in 20 chance in May and 1 in 10 chance in June. The land price may decrease in May and June, with probabilities listed in the tables. If purchased, Westhouser expects $3 million profit from the land, but $650k from alternative investments if not purchased.

Uploaded by

Xuanyi Zhong
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Westhouser Paper Decision Models

Westhouser Paper Decision Tree Example (Adapted from Winston and Albright, Example 2.5)

The Westhouser Paper Company is contemplating purchasing a piece of land with a


good timber forest on it. It is now May 1 and the current price of the land is $2,200,000.
Westhouser does not need the timber from this land until the beginning of July, but
management fears that another company might buy the land between now and then.
They believe that there is 1 chance in 20 that a competitor will buy the land in May. If
this does not occur, they think there is a 1 chance in 10 that the competitor will buy the
land in June. If Westhouser does not purchase the land now, they can attempt to buy
the land at the beginning of June or the beginning of July, if it is still available.

Westhouser's incentive for delaying the purchase is that they believe that the price of
the land might decrease in one or both of the next two months. The possible price
decreases and their probabilities are shown below. Table 1 shows the probability of a
price decrease in May. Table 2 shows the conditional probabilities of the possible price
decreases in June, given the price decrease in May. For example, if the price decrease in
May is $100,000, then the possible price decreases in June are $0 and $50,000 with
probabilities .6 and .4, respectively.

Table 1: Distribution of Price Decrease in May


Price Decrease Probability
$0 .8
$100,000 .2

Table 2: Distribution of Price Decrease in June


Price Decrease in May
$0 $100,000
June Decrease Probability June Decrease Probability
$0 .3 $0 .6
$100,000 .7 $50,000 .4

If Westhouser purchases the land, they will gross $3 million. (This does not count the
cost of purchasing the land.) But if they do not purchase the land, they believe that they
can make $650,000 from alternative investments. What should Westhouser do?

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