Reference no: EM132241742
For the following provide (a) a decision analysis model – either hand-written or using TreePlan, with appropriate information shown – that has been folded back to determine the optimal decision strategy for Global Oil, and (b) a clear written statement of the optimal decision strategy.
Mary has recently been assigned to the economic analysis section of Global Oil. Prescot Oil has just offered to buy the Burns Flat lease from Global for $15,000 and Mary has been assigned the task of preparing Global’s response – that is, a recommendation to either sell the lease or proceed on Global’s intention to exploit the lease.
The Burns Flat lease gives Global the right to explore for oil under 320 acres of land in western Oklahoma. If Global does exploit the lease, by drilling, the results are uncertain. On the basis of drilling records in western Oklahoma and current market prices, Mary prepared the following table showing four possible outcomes, the probability of each outcome, and the net return to Global:
Dry Well – probability: 20% -- net return: loss of $100,000
Gas (only) Discovery – probability: 40% -- net return: profit of $40,000
Oil and Gas Discovery – probability: 30% -- net return: profit of $90,000
Oil (only) Discovery – probability: 10% -- net return: profit of $200,000
Mary knows that she does not have to make her recommendation based on this information alone. Drilling Resource, Inc. (DRI) will perform a test, for $6,000, to determine the underground formation of the terrain of the Burns Flat lease. This test would indicate which of three categories – plate, varied, or ridge – best describes the underground structure. The conditional probabilities of the four possible drilling results vary with the underground structure, as shown in the following data from a recent 50 tests:
When Test Result Was … : Plate Varied Ridge TOTAL
… Drilling Outcome Has Been:
Dry Well - 8 2 0 10
Gas (only) Discovery - 2 16 2 20
Oil and Gas Discovery - 0 14 1 15
Oil (only) Discovery - 0 0 5 5
TOTAL - 10 32 8 50
Mary knows that if a test is made by DRI, the opportunity to sell the lease to Prescot will be lost because, in the market for oil leases, a decision to sell a lease after testing indicates to potential buyers that drilling on that lease doesn’t appear to be attractive/desirable/profitable.
Mary needs to determine Global’s optimal decision strategy – to just sell the lease, or drill without testing, or test first, etc. – in order to arrive at her recommendation.