Peter J Wilcoxen > PAI 789 Advanced Policy Analysis

Buying Information (p08)

This exercise extends the analysis from the previous assignment. As before, 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

From the previous analysis, the agency would want to go ahead with the upgrade and receive an expected payoff of $24 million.

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. You can take into account that if the agency does not hire the consultant, it will do the upgrade for the expected payoff of $24 million.

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Peter J Wilcoxen, The Maxwell School, Syracuse University
Revised 02/07/2024