Question

Chapter 18

1Mr. De Cat is the CEO of an oil company. If he decides to drill, he will drill only one well. He believes the outcomes of the drilling are

Dry Well                                              $0

Small Amount                                   Large Amount

$25 Million                                          $60 Million

It costs $ 10 million to drill a well. Mr. De Cat’s u-curve is

u1x2 = 56.37*x - 324.5

Mr. De Cat asks the company geologist to assess the probabilities of each possibility. The geologist says this assessment depends on whether or not a dome exists. The geologist says there is a 0.7 chance that a dome does exist. He also provides Mr. De Cat with the following information:

5Dry Hole兩Dome, &6 = 0.5 5

Small amount of oil 兩Dome, &6 = 0.3 5

Dry Hole兩No Dome, &6 = 0.7 5

Small amount of oil 兩 no dome, &6 = 0.25

a. What is Mr. De Cat’s certain equivalent for this drilling site?

b. What is the value of information on the presence of the dome?

c. What is the value of information on the amount of oil present?

Answer 1