John Alex, a business owner, is considering opening a second location of his business and has secured a property at the Dar es Salaam city centre. He has
determined his options for leasing property as: commit to a two year lease at
TZS50,000,000 per year or commit to a one year lease at TZS60,000,000. At the
beginning of the second year, he can cancel the two year lease at a cost of
TZS20,000,000 or continue with the lease. If he only signed a one year lease
initially, he has the option of renewing the lease for another year at
TZS60,000,000.
Based on previous experience in the business and his research on the new
location, John Alex estimates there is a 40% chance that sales (net of cost of
goods sold) in the first year will be considered “good” and will amount to
TZS100,000,000; alternatively, they will only amount to TZS30,000,000. If sales
in year one were “good”, the chance of them being “good” in year two as well is
80%. However, if sales in year one were “bad”, the probability of them being
“bad” in year two as well is 90%. Good sales in year two also amount to
TZS100,000,000; and bad sales in year two also amount to TZS30,000,000.
Required:
Solve the decision tree and recommend to John Alex what he should do.