W5_HPO_Decision Tree for House Acquisition Scenario


1. Problem Statement

Currently, Indonesia is suffering a financial instability caused by the tapering issue of US quantitative easing and fundamental deficit of balance of payment. In this uncertain financial condition, inflation affecting the economic growth by giving bigger chance of interest increase. What the best scenario should I have to buy a house if some risk probability affecting the future assets value?

2. Feasible Alternatives

According to Sullivan, if some probabilities arise, the best tool for deciding the best scenario alternative is using decision tree analysis. Future value is used here to present the amount of money probably I will get in the future with calculating all of the value of investment revenue and cost.

3. Develop The Outcome of Each Alternatives

I have some alternatives of when I should buy a house assumed I shall monetize all my assets at the end of year 3.

  • Decision 1: I buy the house now.
  • Decision 2: I buy the house at year 1 and I invest my money at mutual funds for 1 year. The consequences are I should rent a house for 1 year, I must borrow the money if the investment result is under the house’s price, or I invest the remaining money of investment result if  the investment result is above the house’s price.
  • Decision 3: I buy the house at year 2 and I invest my money at mutual funds for 2 years. The consequences are I should rent a house for 2 years, I must borrow the money if the investment result is under the house’s price, or I invest the remaining money of investment result if  the investment result is above the house’s price.

W5_HPO_Fig2

The house’s price at each year is assumed following the real house market situation probability. If I rent a house in period of waiting the house acquisition the rent is assumed to be started at US$2,400/year at year zero and following the real house market situation probability. The assumption I developed for the probabilistic distribution varies among the real and financial market because of the increasing risk of US quantative easing tapering.

I predict the real house market is quite modest situation for:

  • Worst situation: 25% giving the increase of 10%
  • Moderate situation: 50% giving the increase of 20%
  • Best situation: 25% giving the increase of 30%

I predict the financial market is quite uncertain situation for:

  • Worst situation: 60%
  • Moderate situation: 30%
  • Best situation: 10%

Mutual Funds if I invest

  • Worst situation: -10%
  • Moderate situation: 25%
  • Best situation: 30%

Interest Rate if I borrow the money

  • Worst situation: 15%
  • Moderate situation: 12%
  • Best situation: 10%

4. Selection of Acceptable Criteria

The best alternative is the alternative which gives the highest future value.

5. Analysis of Comparison Between Alternative and Criteria

The analysis of each decision is represented below: W5_HPO_Fig1

The result is decision 1 is giving the highest future value among other alternatives.

6. Selection of The Best Alternative

The best scenario is Decision 1 where I should buy the house now because it will give the highest future value.

7. Follow Up Assessment

I will buy the house now and forgetting investment in mutual funds.

References:

J. Erna (2013). 20 reksa dana saham dengan return tertinggi. [ONLINE] Available at: http://ekbis.sindonews.com/read/2013/04/12/32/737333/20-reksa-dana-saham-dengan-return-tertinggi. [Last Accessed 2 November 2013].

Sullivan, W. G., Wicks, E. M., & Koelling, C. P. (2012). The Time Value of Money. In Engineering Economy (15th ed., pp. 104-162). Upper Saddle River, N.J: Prentice Hall.

Sullivan, W. G., Wicks, E. M., & Koelling, C. P. (2012). Probabilistic Risk Analysis. In Engineering Economy (15th ed., pp. 478-521). Upper Saddle River, N.J: Prentice Hall.

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2 Comments

Filed under Hadianto P, Week 05

2 responses to “W5_HPO_Decision Tree for House Acquisition Scenario

  1. Excellent case study and great job on your analysis…….

    Curious why you only chose mutual funds as your investment alternative? I wonder if the results would be the same if you invested in gold vs property?

    You may want to consider that as another posting for future weeks?

    BR,
    Dr. PDG, Jakarta

  2. Hadianto Prasetio

    Yes Sir indeed gold is also an option. Currently, I am thinking gold is not quite an option for now. As long as there’s an issue of tapering. Gold price will be around US$1200-1300 depending on USD dry supply.

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