You have mineral rights on a piece of land that you believe may have oil underground....

You have mineral rights on a piece of land that you believe may have oil underground. There is only a 10% chance that you will strike oil if you drill, but the payoff is $200,000. It costs $10,000 to drill. The alternative is not to drill at all, in which case your profit is zero.

(c) Draw a decision tree to represent your problem. Should you drill?
(d) Use the decision tree to calculate EVPI.
(e) Before you drill you might consult a geologist who can assess the promise of the piece of land. She can tell you whether your prospects are “good” or “poor”. But she is not a perfect predictor. If there is oil, the conditional probability is 0.95 that she will say prospects are good. If there is no oil, the conditional probability is 0.85 that she will say poor. Draw a decision tree that includes the “Consult Geologist” alternative. Finally, calculate the EVII for this geologist. If she charges $7000, what should you do?

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orchestra answered 1 year ago

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