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The Goderbroke company owns a piece of land that may contain oil. A consulting geologist has reported to the management that he believes there is a one in four chance of oil. Due to this prospect, another oil company has offered to purchase the land for $4 million. Goderbroke wants to decide whether to drill to find oil or to sell the land.
Option 1: Directly determine whether to drill or sell Option 2: Conduct seismic experiment, then determine whether to drill - Seismic experiment cost $2 million - If result is favorable (40%), the chance of containing oil is 60% - If result is unfavorable (60%), the chance of containing oil is 10% The drilling operation will cost $5 million If oil is found, the company will earn $40 million If the land sold without drilling, the company would earn $4 million. QUESTIONS: Maximize the company's earnings, what strategy should they choose? Analyze your strategy using decision tree. The best option for the Goderbroke company is to conduct a seismic experiment. If the result of the experiment is favorable, then the company should drill for oil. If the result of the experiment is unfavorable, then the company should sell the land. Conducting a seismic experiment costs $2 million. If the experiment results in a favorable outcome, there is a 60% chance that the land contains oil. If the experiment results in an unfavorable outcome, there is a 10% chance that the land contains oil. Drilling for oil costs $5 million. If oil is found, the company will earn $40 million. If the land is sold without drilling, the company will earn $4 million. By conducting a seismic experiment, the Goderbroke company can maximize its chances of finding oil and earning a profit. decision tree The Goderbroke company should conduct a seismic experiment to determine whether to drill for oil or sell the land. If the result of the seismic experiment is favorable, there is a 60% chance that the land contains oil. In this case, the company should drill for oil. If the result of the seismic experiment is unfavorable, there is a 10% chance that the land contains oil. In this case, the company should sell the land. Conducting a seismic experiment costs $2 million. Drilling for oil costs $5 million. If oil is found, the company will earn $40 million. If the land is sold without drilling, the company will earn $4 million. By conducting a seismic experiment, the Goderbroke company can maximize its chances of finding oil and earning a profit. sensitivity analysis The Goderbroke company should conduct a seismic experiment to determine whether to drill for oil or sell the land
If the result of the seismic experiment is favorable, there is a 60% chance that the land contains oil. In this case, the company should drill for oil. If the result of the seismic experiment is unfavorable, there is a 10% chance that the land contains oil. In this case, the company should sell the land. Conducting a seismic experiment costs $2 million. Drilling for oil costs $5 million. If oil is found, the company will earn $40 million. If the land is sold without drilling, the company will earn $4 million. By conducting a seismic experiment, the Goderbroke company can maximize its chances of finding oil and earning a profit. The following sensitivity analysis shows how the decision of the Goderbroke company changes under different conditions. If the cost of conducting a seismic experiment increases to $3 million, the company should still conduct the experiment. If the cost of drilling for oil increases to $6 million, the company should still drill for oil if the seismic experiment is favorable. If the chance of finding oil decreases to 50%, the company should still drill for oil if the seismic experiment is favorable. If the chance of finding oil decreases to 30%, the company should sell the land if the seismic experiment is unfavorable. conclusion The Goderbroke company should conduct a seismic experiment to determine whether to drill for oil or sell the land
If the result of the seismic experiment is unfavorable, there is a 10% chance that the land contains oil. In this case, the company should sell the land. Conducting a seismic experiment costs $2 million. Drilling for oil costs $5 million. If oil is found, the company will earn $40 million. If the land is sold without drilling, the company will earn $4 million. By conducting a seismic experiment, the Goderbroke company can maximize its chances of finding oil and earning a profit.
The oil firm must decide whether to drill on the property or sell it. You may either decide right away whether to drill or sell, or you can decide to do a seismic experiment first and then decide whether to drill. Spending $2,000,000 on a seismic experiment is a lot. If the test is positive, there is a 60% likelihood that oil is present. If the outcome is bad, there is a 10% probability that it contains oil. The price tag for the drilling project is around $5 million. The corporation stands to gain $40,000,000 if oil is discovered. The corporation stands to gain $4 million if the property is sold without any drilling taking place.
In order to decide whether or not to drill, the corporation should choose the option to perform a seismic experiment. There is a 60% possibility of containing oil, thus the corporation should drill if the test is positive. There is only a 10% possibility that the property contains oil, therefore if the conclusion is adverse, the corporation should sell the land. Company profits will be increased to their maximum potential with this choice.
Alternative 1: Make the drilling/selling decision unilaterally
This decision, whether to drill or sell, should be made by the corporation itself. The corporation should proceed with drilling if the test is positive, since there is a 60% possibility of oil presence. There is only a 10% possibility that the property contains oil, therefore if the conclusion is adverse, the corporation should sell the land. This choice optimizes profits for the business.
Method 2: Perform a seismic test and decide afterwards whether to dig.
The corporation should first decide to do a seismic test, and only after that should it decide whether or not to drill. There is a 60% possibility that the area has oil, thus the corporation should drill if the result is positive. There is only a 10% possibility that the property contains oil, therefore if the conclusion is adverse, the corporation should sell the land. Company profits will be increased to their maximum potential with this choice.
As a third option, the land might be sold without any drilling taking place.
Without drilling, the firm should sell the land. For the corporation, there will be no financial loss from the drilling process, making this the most secure choice. The business will still earn a $4 million profit, however.
Fourth Option: Proceed without first doing a seismic test.
Without first performing a seismic test, the corporation should choose not to drill. Unfortunately, there is no certain method to determine whether or not the area in question contains oil, making this the riskiest of the available choices. It's possible that the corporation will spend $5 million on the drilling operation without actually discovering any oil.
Conclusion
The corporation should first decide to do a seismic test, and only after that should it decide whether or not to drill. There is a 60% possibility that the area has oil, thus the corporation should drill if the result is positive. There is only a 10% possibility that the property contains oil, therefore if the conclusion is adverse, the corporation should sell the land. This choice optimizes profits for the business.
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