Decision and Negotiation Analysis

2019/2020

Corocenter, SA. is an international economic group that is committed to investing in a new

shopping center in Bergamo. At this moment, the most interesting alternatives are to invest in
an old, central and somewhat degraded area of the city or in a more recent residential area,
very populous, but more peripheral to the city.

The first option corresponds to a smaller investment (10 million euros) and its profitability
depends on an urban rehabilitation operation for this area that is being studied by the
Municipality. Within a year, it will be known whether or not urban renewal will take place.
According to information obtained from the Municipality, the probability of urban
rehabilitation being carried out is high, approximately 0.8.

The second option is more focused on recent and peripheral but highly populated residential
areas, and its profitability depends on the consumption habits of residents who traditionally
prefer to do their shopping in the city center. In this option, the Corocenter CEO can choose an
investment similar to the previous one (9 million euros) or a larger investment (15 million
euros). It is expected that the probability of consumption habits changing, if the smaller
investment is selected is 0.65 whereas if the larger investment is selected is 0.75.

It is expected that, any of these investments, will take one year to build and will have a useful
life of 15 years. If the investment is made in the old area, the operational cash flow is dependent
on the decision of urban rehabilitation. The amounts are shown in the following table (values
in thousands of euros):

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 Table 1 – Operational Cash-Flow of investment in the old area
5th year
1st
2nd year 3rd year 4th year and
year
following.
With urban rehabilitation 550 750 900 1000 1250
Without urban rehabilitation 300 400 600 750 900

If the investment is made in the residential area, the operational cash flow depends on
changes in consumption habits, the respective values are shown in the following table (values
in thousands of euros):

Table 2 – Operation Cash-Flow of investment in the residential area

5th year
1st 2nd 3rd
4th year and
year year year
following.
Small investment
Changes in consumption habits 600 700 850 950 1100
No change in consumption habits 500 600 700 900 1000
Large investment
Changes in consumption habits 700 900 1200 1600 1950
No change in consumption habits 550 800 900 1100 1300

Regarding the alternatives of investing in the more recent residential area, it is possible,
during the next year, to hire a market research company to carry out a survey on the residents'
consumption habits and estimate, with some margin of error, whether or not they will be
frequent users of the new shopping center. There is the possibility of doing a study with a small
sample (N = 1000 consumers) with a cost of 240 thousand euros or a study with a large sample
(N = 10,000 consumers) with a cost of 500 thousand euros. The market research company will
predict either a low acceptance of the shopping center by potential consumers (consumption
habits do not change) or a high acceptance of the shopping center (consumption habits change).
The advantage of doing a study with a larger sample is that the reliability of the study increases.
With the small sample the reliability of the study is 70% (that is, the probability of the study
predicting the true state of nature is 70%) whereas with the large sample the reliability of the
study increases to 85% (that is, with 85% probability, the study correctly predicts the true state
of nature).
Additional information:
• Cash-flow discount rate: 5% per year
• It takes 1 year for the shopping center to be built

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 • Corocenter’s CEO has one year to decide whether to invest and if it decides to invest, where
to invest.
• The Residual Value of the Investment at the end of the 15th year of operation is 15% of the
value of the initial investment.
• Corocenter intends to invest in just one shopping center, and only this company is
authorized to do these investments (if it opts for the shopping center in the old area, the
shopping center in the residential area will not be made, and vice versa).

Your group (a Management Science consultant firm) was hired by Corocenter to give her
advice on the issues described above. You must write a professional report which includes the
analysis of the problem, conclusions and recommendations of your group to the Corocenter. In
addition, you should send the excel file where you performed your computations (the quality of
this file will be take into account in the grading). Corocenter’s CEO asked you explicitly to
analyse the following points (but you can go further and analyse other things since creativity
will be valued):

1. Before drawing the tree, prepare a good model in Excel with the relevant data
and some preliminary calculations (which are already outputs of the model). You should
clearly distinguish the inputs and the outputs of the model. In the outputs, you should
calculate the posterior probabilities of consumer habits changing based on the results of
the market study, using Bayes’ Theorem.
2. Draw the decision tree (the payoffs should be written in thousand euros).
Identify the optimal strategy, assuming that Corocenter’s CEO objective is to maximize
the expected net present value.
3. There are many parameters that are crucial, but 3 of them are: (i) the prior
probabilities of the shopping centre’s and the probabilities of the urban requalification
in the old zone; (ii) the investment; and, (iii) the cost of the two studies. Corocenter is
interesting in knowing how these parameters may affect the optimal strategy.
4. The level of risk is a very important information. Analyse the risk profile of this
problem.
5. Suppose that Corocenter’s CEO attitudes face the risk is represented according to
the exponential utility function available in Precision Tree. How does his risk tolerance

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 influence the optimal strategy? Analyze the CEO risk attitudes The analysis of CEO risk
attitudes in different decision nodes of the decision tree will be valorized.

The grade in this group project will take into account both the quality of your
analysis/conclusions as well as the quality of the report (if it is well structured, if it is well
written, ...). If you write the Report in Portuguese, the maximum grade is 20. If you write the
report in English and you are taking the English classes, the maximum grade is 21,5 (the idea
of this extra-credit is to give you an incentive to write in English, which is a valuable skill in the
job market).

The report should be structured as follows:

-Executive Summary. Describes briefly the findings and recommendations. You should
use non-technical language. Do not include anything that is not also in the main text. (±1
page).

-Introduction . Describes the problem. You can explain the importance of its resolution.

-Problem(s) Analysis. More technical part of the report. In this case you should include
the construction of the decision tree and the identification of the optimal strategy. In
addition, you should include risk analysis, sensitivity analysis of some factors
considered critical and an analysis of how the degree of risk tolerance may affect the
optimal strategy. In this section it is extremely important that you interpret all the
results (tables or graphs without interpretations are worthless).

-Conclusions and Recommendations. Here you describe the main conclusions and
recommendations of the study. They are explained in more detail than in the executive
summary.

-Appendix – Includes materials that may help to complement the analysis.

Deadline for submission: 3/4/2020