The Americo Oil Company is considering making a bid for a shale oil development contract to be awarded by the federal government. The company has decided to bid $112 million. The company estimates that it has a 60% chance of winning the contract with this bid. If the firm wins the contract, it can choose one of three methods for getting the oil from the shale. It can develop a new method for oil extraction, use an existing (inefficient) process, or subcontract the processing to a number of smaller companies once the shale has been excavated. The results from these alternatives are as follows: Develop new process: Outcomes Probability Profit ($1,000,000s) Great success .30 $ 600 Moderate success .60 300 Failure .10 -100 Use present process: Outcomes Probability Profit ($1,000,000s) Great success .50 $ 300 Moderate success .30 200 Failure .20 -40 Subcontract: Outcome Probability Profit ($1,000,000s) Moderate success 1.00 250 The cost of preparing the contract proposal is $2 million. If the company does not make a bid, it will invest in an alternative venture with a guaranteed profit of $30 million. Construct a sequential decision tree for this decision situation and determine whether the company should make a bid.
The Americo Oil Company is considering making a bid for a shale oil development contract to
be awarded by the federal government. The company has decided to bid $112 million. The company
estimates that it has a 60% chance of winning the contract with this bid. If the firm wins
the contract, it can choose one of three methods for getting the oil from the shale. It can develop
a new method for oil extraction, use an existing (inefficient) process, or subcontract the processing
to a number of smaller companies once the shale has been excavated. The results from these
alternatives are as follows:
Develop new process:
Outcomes Probability Profit ($1,000,000s)
Great success .30 $ 600
Moderate success .60 300
Failure .10 -100
Use present process:
Outcomes Probability Profit ($1,000,000s)
Great success .50 $ 300
Moderate success .30 200
Failure .20 -40
Subcontract:
Outcome Probability Profit ($1,000,000s)
Moderate success 1.00 250
The cost of preparing the contract proposal is $2 million. If the company does not make a bid,
it will invest in an alternative venture with a guaranteed profit of $30 million. Construct a sequential
decision tree for this decision situation and determine whether the company should
make a bid.
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