Reference no: EM131781715
The Mobile Oil company has recently acquired oil rights to a new potential source of natural oil in Alaska. The current market value of these rights is $90,000. If there is natural oil on the site, it is estimated to be worth $800,000; however, the company would have to pay $100,000 in drilling costs to extract the oil. The company believes there is a 0.25 probability that the proposed drilling site would actually hit the natural oil reserve. Alternatively, the company can pay $30,000 to first carry out a seismic survey at the proposed drilling site. The probability of a favorable seismic survey when oil is present at the drilling site is 0.6. The probability of an unfavorable seismic survey when no oil is present is 0.80.
a) What is the probability of a favorable seismic survey?
b) What is the probability of an unfavorable seismic survey?
c) Construct a decision tree for this problem
d) What is the optimal decision strategy using the EMV criterion?
e) To which financial estimate in the decision tree is the EMV most sensitive?
I found an answer already that I have attached in regards to the construction of the tree plan but it was incorrect.
My professor emailed me to correct it with this response:
"There is a basis flaw in the logic of your treeplan.
It is that the no drill option that you assumed does not exist, but a sell option with a positive net asset value does. Redo it with that in mind. See you Monday night."
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