The Mobile Oil company has recently acquired oil rights to the new potential source of natural oil in Alaska. The current market value of these rights is $90,000. If there is natural oil upon the site, it is estimated to be worth $800,000; but, the company would have to pay $100,000 in drilling costs to extract the oil. The company thinks there is a 0.25 probability that the proposed drilling site would actually hit the natural 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.
a) What is the probability of a favorable seismic survey?
b) What is the probability of an unfavorable seismic survey?
c) Construct a decision tree for this problem
d) What is the optimal decision strategy using the EMV criterion?
e) To which financial estimate in the decision tree is the EMV most sensitive?