Task:
The Oxenol Company uses natural gas in its production processing operations. Neighboring companies in its upstate New York area have successfully drilled for gas on their premises, and Oxenol is considering following suit. If their initial expenditure would be for drilling: this would cost $40,000. If they struck gas, they would have to spend an additional $30,000 to cap the well and provide for the necessary hardware and control equipment. At the current price of natural gas, if the well is successful it will have a value of $150,000. However, if the price of gas rises to double its current value, a successful well will be worth $300,000. The company thinks its chance of finding gas is 30 percent; it also believes that there is a 50 percent chance that the price of gas will double.
Q1. Draw a decision tree for this problem, filling in the probabilities and values.
Q2. Complete the tree by calculating EMV's. (I am assuming this means expected market value?) What should the company do?