Reference no: EM131641876

Question: The senior executives of an oil company are trying to decide whether to drill for oil in a particular field in the Gulf of Mexico. It costs the company $600,000 to drill in the selected field. Company executives believe that if oil is found in this field its estimated value will be $3,400,000. At present, this oil company believes that there is a 45% chance that the selected field actually contains oil. Before drilling, the company can hire a geologist at a cost of $55,000 to prepare a report that contains a recommendation regarding drilling in the selected field. In many similar situations in the past where this geologist has been hired, the geologist has predicted oil on 75% of all fields that have contained oil, and he has predicted no oil on 85% of all fields that have not contained oil.

a. Assuming that this oil company wants to maximize its expected net earnings, use a decision tree to determine its optimal strategy.

b. Calculate and interpret EVSI for this decision problem. Experiment with the accuracy probabilities of the geologist to see how EVSI changes as they change.

c. Calculate and interpret EVPI for this decision problem.