PAI 789 Advanced Policy Analysis

Buying Information (p07)

An agency is considering whether to upgrade its computer network. Its current system (C) costs $10 million to operate and produces $30 million in gross benefits. If it upgrades (U), its costs will go up to $20 million. However, as indicated in the table below, the impact of the upgrade on gross benefits is uncertain.

Probability State Benefit
60% Succeeds (S) $60M
40% Fails (F) $20M

Part 1

Please draw an appropriate decision tree and compute the expected value of the upgrade. Should the agency proceed?

Part 2

Now let's make things more interesting. Suppose a consulting firm has offered to carry out a study that would determine whether or not the network upgrade would succeed before the agency undertakes it. The study would cost $4 million.

Please draw an appropriate decision tree and determine whether or not the agency should hire the consulting firm.

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Peter J Wilcoxen, The Maxwell School, Syracuse University
Revised 03/14/2022