A chief executive of an oil company must decide whether to drill a site and, if

Question

A chief executive of an oil company must decide whether to drill a site and, if so, hew deep. It costs $160,000 to drill the first 3,000 feet, and there is a 0.4 chance of striking oil. If oil is struck, the profit (net of drilling expenses) is $600,000. If she does not strike oil, the executive can drill 2,000 feet deeper at an additional cost of $90,000. Her chance of finding oil between 3,000 and 5,000 feet is 0.2 and her net profit (after all drilling costs) from a stroke at this depth is $400,000. What action should the executive take to maximize expected profit?

Explanation / Answer

profit if the executive drill till only 3000 ft = 600000*0.4 - 160000 = $80000 profit if the executive drill till beyond 3000 ft = 400000*0.2 = $80000 So both the procedure are costing the same to the executive. so either of them can be taken to maximize expected profit

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