Question

. The XYZ Company develops oil wells in unproven territory. A consulting geologist has reported that there is a one-in-four chance of oil on a particular tract of land. • Drilling for oil on this tract would require an investment of about $100,000 • If the tract contains oil, it is estimated that the net revenue generated would be approximately $900,000. • Another oil company has offered to purchase the tract of land for $90,000 Question: a. Should XYZ drill for oil or sell the tract? Please draw the decision tree model, provide the calculation and final decision. b. If the probability of the land containing oil becomes 15%, drill or sell? Please draw the decision tree model, provide the calculation and final decision Show Exp Upload Choose a File e here to search O

Answer 1

Date Page $0 No oil (0.75) (a) Toef No Oil (0.25) $ 900,000 Sell the tract $ 90,000 FOXDUR Expected Value - E Probability X Pay off Fax Drill fox oil Expected Value = 0.75 xo +0.25 x 900,000 => $ 225,000 Investment -> $ 100,000 Net Profit $225.000 – $100,000 $125,000 Profit for sell the tract = $90,000 * Net Scanned by TapScanner

Dale Page Since net profit of drill for oil is higher, there feroe best decision is to dvill for oil. Scanned by TapScanner

Date Page $0 No oil (0.85) (ط) Din for oil Oil (0.15) $ 400,000 Sell the tract $90,000 感AVASA Expected Value = Ei E Probability x Payoff For Drill for oil Expected Value = 0.85 X0 +0.75 x 900,000 = $ 135 000 Investment => $100,000 Net Profit *$35.000 $ 100,000 ~$ 35,000 * Net Profit for sell the tract >> $90,000 Scanned by TapScanner

Date Page Since net profit of of sell the tract is higher, therefore best decision is to sell the tract. Scanned by TapScanner

All the parts have been done as shown.