Question

1. An oil company owns some land that is purported to contain oil. The company classifies such land into four categories by the number barrels that are expected to be obtained from the well.

Land category 1: a 500,000 barrel well

Land category 2: a 200,000 barrel well

Land category 3: a 50,000 barrel well

Land category 4: a dry well.

The probabilities of each type of well are given in the table below

Category	Land category 1: a 500,000 barrel well	Land category 2: a 200,000 barrel well	Land category 3: a 50,000 barrel well	Land category 4: a dry well.
Probability	0.1	0.15	0.25	0.5

The company is faced with deciding whether

1. to drill for oil
2. to unconditionally leases the land to an independent oil driller, or
3. to conditionally lease the land at a rate depending on the oil strike.

If the company decides to drill for oil, the cost of producing a producing well is $100,000, and cost of drilling a dry well is $75,000. For producing wells the profit per barrel of oil is $1.50 (after deducting all production costs).

If the company decides to unconditionally lease the land, the company receives $45,000 for the land only.

If the company decides to conditionally lease the land it receives $0.50 for each barrel of oil produced if the land yielded more than 100,000 barrels of oil, and $0 if the land produces less that 100,000 barrels of oil.

1. Draw and properly label a decision tree.
2. Evaluate the decision tree.
3. Determine the optimal policy/decision.

Answer 1