Reference no: EM131284118

The government of Ghana (GOG) is to decide next month whether to undertake a new yet promising oil exploration close to Cape Three Point in the Western region by itself or to sell the exploration right to Tullow Oil Company. Preliminary studies have confirmed an oil find in the area and there is a 70% chance large quantities of oil would be found. Self-exploration by the GOG will demand a one-time investment of $400M and will last for a year. After this, if a large quantity of oil is found, it may lease it at $160M per year to a foreign oil firm for 40 years or undertake self-production. Under self-production, there is a 50/50 chance that production cost would be high therefore yielding a profit of $70M per year for 40 years or $200M per year for 40 years if production cost is low. If however a smaller quantity of oil is found, it may lease to a foreign oil firm at an expected value of $50M per year for 20 years. Tullow on the other hand has quite an interesting bid. Exploration will take one year and, if a large quantity of oil is found, it will pay GOG $170M per year for 35 years if a new drilling technology under research by Tullow’s R&D department is successful, but only $70M per year for 35 years if the technology is unsuccessful. If a smaller quantity of oil is found, it will offer GOG $70M per year for 20 years and $30M per year for 20 years if the technology under research is successful or unsuccessful respectively. There is a 75% chance the new technology under design would be successful. a. Draw a decision tree for the problem faced by GOG including the probabilities of occurrence, the yearly profit, and the duration profit is received. You are encouraged to use pencil. b. Ignoring time value of money, advice the GOG on which decision to take. Show your work. c. Consider all time periods above 15 years as sufficiently long to be considered ‘forever’. If interest rate is expected to remain at 5% each year, will your decision in question b above change? Show your work.