22. 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 nat- ural 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 natural oil re- serve. Alternatively, the company can pay $30,000 to first carry out a seismic survey at the proposed drilling site. Historically, if the seismic survey produces a favorable re- sult, there is a 0.50 chance of hitting oil at the drilling site. However, if the seismic sur- vey produces an unfavorable result, there is only a 0.14285 probability of hitting oil. 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?