PLEASE ONLY ANSWER QUESTION IN TREEPLAN WITH ATTACHED FILE! I DO NOT WANT JUST T

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PLEASE ONLY ANSWER QUESTION IN TREEPLAN WITH ATTACHED FILE! I DO NOT WANT JUST THE ANSWER WITH NO EXPLANATION.

Shamrock oil owns a parcel of land that has the potential to be an underground oil field. It will cost $500,000 to drill for oil. If oil does exist on the land, shamrock will realize a payoff of $4,000,000 (not including drill cost). With current information, shamrock estimates that there is a 0.2 probability that oil is present on the site. Shamrock also has the option of selling the land as is for $400,000, without further information about the likelihood of oil being present. A third option is to perform geological test at the site, which would cost $100,000. There is a 30% chance that the test results will be positive, after which shamrock can sell the land for $650,000 or drill the land, with a 0.65 probability that oil exists. if the test results are negative, shamrock can sell the land for $50,000 or drill the land, with a 0.05 probability that oil does exists.

a) construct the appropriate decision tree to make the appropriate decision. Including the revised probabilities

b) fold back the decision tree. what is the final expected profit?

c) What is the expected value of sample information (EVSI)

d) Calculate the expected value of perfect information (EVPI) e) what is the efficiency of sample information?

Explanation / Answer

This is a two stage Decision making problem with uncertain outcomes representing different states of nature. At the first Decision node three alternatives to make choice are 1.Drill for oil, 2. Sell the land as is, and 3. Perform geological test

Alternative 1. has two states of nature, either oil is present or no oil is present. In case oil is present net payoff is ($4,000,000-$500,000) with probability 0.2 otherwise payoff is negative in terms of drill cost $500,000 with probability .8 (1-.2). Therefore expected pay off is (3,500,000*.2)+(-500,000*.8) = $300,000

Alternative 2. Payoff is equal to sales price of $400,000

Alternative 3. Involves cost of test $100,000 with two outcomes of Positive (probability of .3) or Negative. Each outcome has Decision node representing two options of either selling or drilling. Net payoffs varies with the states and are based on the probabilities and values of outcomes as follows:

In case of positive, payoff for selling is $550,000 and expected payoff for drilling is (3,400,000*.65)+(-600,000*.35) and the choice is drill. In case of negative the choice is to sell because drilling has higher negative payoff.

Details with data in the form of decision tree is as follows:

The conclusion is in favor of conduct the test and in case outcome is positive go for drilling and in case outcome is negative sell. Expected payoff is highest as $560,000 = [ (2000000*.3)+(-50000*.7)]

Payoff Prob. 300000 Oil present 35,00,000 0.2 Drilling EMV 300000 No oil -500000 0.8 400000 D1 Sell 400000 payoff Prob. Oil present 34,00,000 0.65 Drilling EMV 2000000 Prob.(.3) No oil -600000 0.35 Positive D2 565000 Sell 550000 Test Oil present 34,00,000 0.05 Drilling EMV -400000 Prob.(.7) No oil -600000 0.95 Negative D2 Sell -50000

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