An oil explorer must decide whether to drill on a site before her option expires or to abandon her rights to the site. Drilling a well costs $100,000. If oil is struck, the explorer will sell and make a $500,000 profit. The explorer can hire a geologist to take a seismic sounding of the site at the cost of $10,000. Such soundings reveal, with certainty, whether the geophysical substructure of the land is of type A, type B or Type C, where
An oil explorer must decide whether to drill on a site before her option expires or to abandon her rights to the site. Drilling a well costs $100,000. If oil is struck, the explorer will sell and make a $500,000 profit. The explorer can hire a geologist to take a seismic sounding of the site at the cost of $10,000. Such soundings reveal, with certainty, whether the geophysical substructure of the land is of type A, type B or Type C, where each type has a different degree of favorability for the existence of oil. From experience, the probability that a certain substructure will occur, given that oil exists, is P(type A|oil) = 14/28 P(type B|oil) = 9/28 P(type C|oil) = 5/28. Further, the following probabilities for substructures at this site are P(type A) = 0.20 P(type B) = 0.30 P(type C) = 0.50 given that P(oil) = 0.28. Perform a decision tree analysis. Determine the EVPI and EVE.
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