The management of an oil company is trying to decide whether to drill for oil in a particular field in the Gulf of Mexico. It costs the company $600 thousand to drill in the selected field. The management believes that if oil is found in this field, its estimated value will be $3400 thousand. At present, this oil company believes that there is a 45% chance that the selected field actually contains oil. Before drilling, the oil company can hire a team of geologists to perform seismographic tests at a cost of $55 thousand. Based on similar tests in other fields, the tests have a 25% false negative rate (no oil predicted when oil is present) and a 15% false positive rate (oil predicted when no oil is present). A. Assume the oil company wants to maximize its expected net earnings. Please utilize decision tree analysis to determine its optimal strategy. B. Calculate the expected value of the information (EVI/EVSI) provided by the team of geologists. C. Calculate and interpret EVPI for this decision tree problem.
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The management of an oil company is trying to decide whether to drill for oil in a particular field
in the Gulf of Mexico. It costs the company $600 thousand to drill in the selected field. The
management believes that if oil is found in this field, its estimated value will be $3400 thousand. At
present, this oil company believes that there is a 45% chance that the selected field actually contains
oil. Before drilling, the oil company can hire a team of geologists to perform seismographic tests at a
cost of $55 thousand. Based on similar tests in other fields, the tests have a 25% false negative rate
(no oil predicted when oil is present) and a 15% false positive rate (oil predicted when no oil is
present).
A. Assume the oil company wants to maximize its expected net earnings. Please utilize decision
tree analysis to determine its optimal strategy.
B. Calculate the expected value of the information (EVI/EVSI) provided by the team of
geologists.
C. Calculate and interpret EVPI for this decision tree problem.
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