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February 18th, 2011, 06:41 PM   #1
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Decision Analysis

Hello guys! Can you help me check whether the decision tree is right? And also how to compute for letters b, c, and d.

SHEEHAN PETROLEUN WILDCATTER ASSOCIATES
Pat Sheehan came to Texas - Oklahoma area from his native Ireland 20 years ago. He quickly went to work for a company drilling wells for oil and gas. After gaining considerable working experience, he and several co-workers formed their own company. Sheehan Petroleum Wildcatter Associates (SPWA).
SPWA combines the drilling skills and capabilities of its partners with the expertise of consultant geologists and the financial backing of private investors. Although the company owns much of its own drilling equipment, it frequently leases additional equipment. Their method of operation is to locate possible drilling sites, obtain drilling leases on the land, and carry out drilling operations. They then sell off the rights to produce gas or oil from any wells that are “brought in.”
Sheehan and his associates are now in the process of deciding what to do about a promising area in southern Oklahoma, on which they have obtained a lease. The cost to drill a well on this site is $1.75 million. This amount would be lost if the well turned out to be dry, and there is no way to establish with 100% certainty whether that would happen. On the other hand, the well might turn out to be a producer of either gas or oil. A gas well would typically return a profit of about $4 million above drilling and lease costs, and an oil well would return to average profit of about $15million above drilling and lease costs.
Additional information on the likelihood of success can be gained by making a seismic survey of the site. Such a survey would cost $250,000 and would indicate whether the underlying rock formation was likely to contain a geologic dome that would form a reservoir for collecting a gas or oil. Although successful gas or oil wells are sometimes drilled in areas that have no underlying dome, the chance of finding either gas or oil is substantially better if a dome is present. Sheehan and his associates think there’s about a 40% probability that the drilling tract has a dome.
Seismic surveys are not 100% accurate. Based on past results from making seismic surveys, the chances that such a survey would be right or wrong are shown in the table.
Existence of Dome in
Underlying Formation Indication from
Seismic Survey Probability of
Getting Indication

Dome actually exists.
Dome exists. 0.89
Dome does not exist. 0.11

No dome exists.
Dome exists. 0.16
Dome does not exist. 0.84
If the underlying rock formation actually contains a dome, the probabilities for the outcomes of drilling are as follows:
Outcome Probability
Dry hole 0.55
Gas well 0.35
Oil well 0.10
On the other hand, if the underlying rock formation does not contain a dome, the probabilities for the outcomes of drilling are as follows:
Outcome Probability
Dry hole 0.88
Gas well 0.10
Oil well 0.02
SPWA is faced with two decisions - whether or not to spend $250,000 to make a seismic survey and, regardless of whether the seismic survey is made or not, whether or not they should drill a site.
a. What course of action do you recommend, and what is its expected profit or loss? Justify your recommendation by showing your analysis and the results of any calculations in a well-labeled format that can be easily understood.
b. What’s most likely to happen if SPWA follows your recommended course of action? How likely is it?
c. What’s the maximum possible profit if SPWA follows your recommended course of action? How likely is it?
d. What’s the maximum possible loss if SPWA follows your recommended course of action? How likely is it?
e. What’s the maximum possible profit if SPWA drills without making a seismic survey? How likely is it?
f. What’s the maximum possible loss if SPWA drills without making a seismic survey? How likely is it?

a. Acquire Seismic survey=$9,317,600=$11.4M×$0.452+$7.6M×0.548
Don^' t acquire=$2M=$1.75M+$250,000
Decision: Acquire Seismic Survey
Drill a site whether the survey is made or not

b.
c.
d.
e. $ 2,187,500 is the maximum possible profit if SPWA drills w/o making a seismic survey.
f. $ 590,000 is the maximum possible loss if SPWA drills w/o making a seismic survey.

aspirare21a is offline  
 
April 1st, 2011, 11:04 AM   #2
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Re: Decision Analysis

I’m trying to follow your decision tree. The numbers to the left of the green circles with a dollar sign look like averages. The decimal numbers look like probabilities. Why do your probabilities change for the existence of the various types of wells based on if you acquire or don’t acquire the lease. Are you assuming if you aquire the lease that you will only drill if there is oil? Why do you think this is a reasonable assumption? The blue boxes look like decision boxes. How are the numbers on the left of the decession boxes calculated?
John Creighton is offline  
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