Reference no: EM13120981

A local energy provider offers a landowner $180,000 for the exploration rights to natural gas on a certain site and the option for future development. This option, if exercised, is worth an additional $1,800,000 to the landowner, but this will only occur if natural gas is discovered during the exploration phase. The landowner, believing that the energy company's interest is a good indication that gas is present is interest in in developing the field herself. To do so she must contract with local experts in natural gas exploration and development. The initial cost for such a contract is $300,000, which is lost forever if no gas is found on the site. If gas is discovered, however, the landowner expects to earn profits of $6,000,000. The probability that gas is on the site is 60%. Suppose that at a cost of $90,000 the landowner can request that a soundings test be performed on the site where the natural gas is believed to be present. The company that conducts the test states that 30% of the time the test will indicate no gas is present if gas is actually present. When no natural gas is present the test is accurate 90% of the time. Find the best set of decision for the landowner to maximize her profit.