Don Smith’s Decision Don Smith has decided to build a new house. He has already purchased the property, signed a contract for the lumber, contracted a.

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Presentation transcript:

Don Smith’s Decision Don Smith has decided to build a new house. He has already purchased the property, signed a contract for the lumber, contracted a builder, and sold his old house. Problem: Rising prices for lumber have changed the price demanded by the mill for the lumber

Details Don must make a decision soon. He must be out of his house at the end of the summer. He has paid $3000 as a down payment of the $30,000 lumber cost.

Options 1.Pay the mill the extra $10,000 they are asking. 2.Get a refund on his $3000 and find a different lumber supplier. 3.Take legal action against the mill.

1. Pay the extra $10,000 This is the “no hassle” option. The house will be built on time and his family will have a place to live. Problems: –may not be the most “economical” choice –goes against Don’s pride

2. Get a refund Lumber prices have risen since the original contract was signed. A friend of Don’s in the industry says he will have to spend from $35,000 to $75,000 for a similar contract now. Problem: uncertainty in the price

3. Legal action A lawyer friend of Don’s thinks that there is a 75% chance he will win a lawsuit against the mill. If he wins, he will get the cost of the lumber above the contract price plus $3000. If he loses, Don will pay $7000 in legal fees and the cost of the new lumber.

3b. Revised legal action Don can hire a lawyer for $700 to increase his chances of winning the lawsuit.

Decision Tree

Decision Tree (reduced)

Tornado Diagram for Legal Outcome with Advice Here is a tornado diagram showing how Don’s chances of winning by hiring a lawyer change the expected value of the legal action choice. (The chance of success range goes from 60% to 99%. The decision tree assumed a 90% chance of success with a lawyer) The expected values ranges from -$32,000 (60%) to -$27,800 (99%)

Results Expected values: –Accept new contract price: -$37,000 –Find a different lumber supplier: -$32,000 –Take legal action: Without lawyer: -$29,500 With a lawyer: -$32,000 to -$28,700

Decision Don should hire a lawyer. It is probably unreasonable to assume that his chances of winning will go down with the help of a lawyer.