What is the net present value of not testing

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There is a 35% chance that the amount of oil in a prospective field is 5 million barrels and a 65% chance of 14 million barrels. If the actual amount of oil is 5 million barrels, the present value of the cash flows from drilling will be $1 million. If the amount is 14 million barrels, the present value will be $8 million. The cost to drill the well is $5.5 million. Suppose, a test that costs $450,000 can verify the amount of oil under the ground, is it worth paying for the test?

Problem 1: What is the net present value of not testing?

Problem 2: What is the net present value of testing?

Problem 3: Should the company perform the test to verify the amount of oil under the ground?

Reference no: EM132752591

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