Consider the preceding oil-wildcatting problem. The basic tree is shown in Figure 12.14.Based on Figure 12.14, work through these steps:

a. Change P(Strike Oil) from 0.1 to 1.0 and P(No Oil) to 0.0. What is the EMV for the decision tree? Record this as EMV | Strike Oil.

b. Now change P(Strike Oil) to 0.0 and P(No Oil) to 1.0. What is the EMV for the decision tree? Record this as EMV | No Oil.

c. Calculate 0.1 EMV | Strike Oil + 0.9 EMV | No Oil. How would you explain the meaning of the resulting value?

d. Finally, from the result in part c, subtract the original EMV of the tree ($10,000) as shown in Figure 12.14. The answer you get is the EVPI for whether you strike oil. Explain why this approach gives the same result as calculating EVPI by moving the chance node before the decision node as described in the chapter.

Figure 12.14

Transcribed Image Text:

oil(0.1)s190K Drill EMV S10K Dr Hole (0.9S10K Don't Drill