An oil company must decide whether or not to drill an oil well in a particular area that they already own. The decision maker (DM) believes that the area could be dry, reasonably good or a bonanza. See data in the table which shows the gross revenues for the oil well that is found. Decision Dry (D) Drill $0 Abandon $0 Probability 0.3 Reasonably good(G) $85 $0 0.3 Bonanza(B) $200 m SO 0.4 Drilling costs 40M. The company can take a series of seismic soundings ( at a cost of 12M) to determine the underlying geological structure. The results will be either "no structure","open structure or "closed structure". The reliability of the testing company is as follows that is, this reflects their historical performance. Note that if the test result is "no structure" the company can sell the land to a developer for 50 m. otherwise (for the other results) it can abandon the drilling idea at no benefit to itself.
An oil company must decide whether or not to drill an oil well in a particular area that they already own. The decision maker (DM) believes that the area could be dry, reasonably good or a bonanza. See data in the table which shows the gross revenues for the oil well that is found. Decision Dry (D) Drill $0 Abandon $0 Probability 0.3 Reasonably good(G) $85 $0 0.3 Bonanza(B) $200 m SO 0.4 Drilling costs 40M. The company can take a series of seismic soundings ( at a cost of 12M) to determine the underlying geological structure. The results will be either "no structure","open structure or "closed structure". The reliability of the testing company is as follows that is, this reflects their historical performance. Note that if the test result is "no structure" the company can sell the land to a developer for 50 m. otherwise (for the other results) it can abandon the drilling idea at no benefit to itself.
Chapter19: Pricing Concepts
Section: Chapter Questions
Problem 6DRQ
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