Mock exam 4: answers

Analysis
From the perspective of risk aversion, the bidding directly for licences appears the best option.
Potential losses are minimised ($20m, compared to $110m) and potential returns maximised
($390m compared to $300m). If expected values are used which represent the current
bidding rules, then this conclusion remains valid.
Scenario Net gain (loss) Probability Expected
value
$m $m
Buy and lose (110) 0.6 (66)
Buy and win 300 0.4 120
Bid and win 390 0.4 156
Bid and lose (20) 0.6 (12)
The buying option has a net expected gain of $54m, compared to a net expected gain for the
bid option of $144m.
However, if the bidding rules are changed to favour the incumbent, then the buy option has a
greater expected return ($136m compared to $62m).
Scenario Net gain (loss) Probability Expected

ox
value
$m $m
Buy and lose
Buy and win
Bid and win
(110)
300
390
0.4
0.6
0.2
lB (44)
180
78
ba
Bid and lose (20) 0.8 (16)
However, a number of issues have to be raised.
lo

(a) The statistical probability values for the changed bidding rules are based on research
conducted in other countries where bidding is biased towards the current licence
G

holders. These may not be appropriate for TFS. They could be too high or too low.
(b) Expected values are really more appropriate for a series of decisions, where, over time,
A

the return will tend towards the expected value. The actual values will occur (subject to
forecast errors) – not the expected ones.
C

(c) The bid price of $550m is itself an estimate and the probabilities of bid success only
AC

relate to this bid price. The analysis might suggest that a higher bid is made, which
should have a higher probability of success. For example, a direct bid of $750m from
2Tel would still lead to a net profit of $190m for the contract – a return of over 20%.
(d) No probabilities have been attached to the chance of the government changing the
selection rules before the next licences are allocated.
2Tel might also like to take a second look at the buy and lose option. The unattractiveness of
this scenario is largely due to the proposed purchase price of T-Me. It may be possible to
reduce or restructure this price, or both. For example, the company could offer $290m now,
and $110m on successful gaining of the next contract. However, the possible compensation
claims are problematic. They are difficult to predict and, at this stage, it would seem unlikely
that they can be insured against (risk transfer).
Conclusion
Under the current licence allocation arrangements, the agreed price for T-Me is too high, given
the risks involved. So, the recommendation is to bid directly for the licence. However, if the
purchase price for T-Me could be renegotiated or restructured, then there are advantages of
acquiring T-Me and using this as a vehicle for the bid.

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