The Mobile Oil company has recently acquired oil rights to a new potential source of natural oil in Alaska. The current market value of these rights is $90,000. If there is natural oil at the site, it is estimated to be worth $800,000; however, the company would have to pay $100,000 in drilling costs to extract the oil. The company believes there is a 0.25 probability that the proposed drilling site actually would hit the natu- ral oil reserve. Alternatively, the company can pay $30,000 to first carry out a seismic survey at the proposed drilling site. The probability of a favorable seismic survey when oil is present at the drilling site is 0.6. The probability of an unfavorable seismic survey when no oil is present is 0.80.
Construct a decision tree for this problem.
What Is A Decision Tree:
When companies have to make important strategic decisions, it is common for them to draw a Decision Tree in order to help them understand their options. A Decision Tree shows the various possible outcomes along with their probabilities.
Answer and Explanation:
See the image below. Note that the payouts for a favorable or unfavorable seismic study (i.e. how they would impact the value of the oil rights) is not provided in the question.
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from Introduction to Management: Help and ReviewChapter 2 / Lesson 12