Question

2) Decision tree

a) An oil company executive is evaluating a piece of land for drilling. Experience and previous geological investigation show a 10% chance of finding oil in commercial quantity. Cost of drilling is estimated at £100,000, but if oil is found in commercial quantity, revenue expected is £750,000 (net present value). Construct the decision tree and recommend the course of action

b) Another alternative is to drill or abandon, is to test. This involves spending £50,000 on an elaborated geophysical survey. Past experience shows that if testing is positive there is a 90% chance there is oil in commercial quantity. However, if testing is negative, then there is only 1% chance of finding oil in commercial quantity. Extend the decision tree (from a) and give your recommendation.

Answer 1