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Value of Information FOR MORE CLASSES VISIT
www.tutorialoutlet.com Part A, Value of
Information Suppose a city is considering
developing a brownfield site but believes there
is a 50 chance the site is contaminated with
hazardous waste. If the site is clean (call that
state quotCquot), the net present value of
development will be 10 million. However, if the
site is discovered to be contaminated during the
construction process (call that state
quotDquot for quotdirtyquot), the site
will have to be remediated and the net present
value will be -20 million. It is possible to
test the site for contamination prior to making
the decision to develop. However, the test costs
1 million and is imperfect when contamination
is present, the test will fail to detect it 20
of the time. Moreover, the test has a 10 chance
of falsely indicating that a clean site is
contaminated. What is the expected present value
of the test? Should the city buy it? In doing
your calculations, you should assume that if the
city chooses not to develop, it does not have to
pay any remediation costs -- it only has to pay
for the test itself.
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