MGS3100 Project#3Decision Analysis - To Drill or Not to Drill?

(revised 12-28-04)

Instructions

Read the case in your text at the end of the chapter on Decision Analysis (see pages 144-45) entitled, “To Drill or Not to Drill”. However, follow the following instructions instead of the instructions in the text:

Create a joint probability table. Then calculate the posterior probabilities to put on the upper (test) part of your decision tree. Make sure that you include this table in your paper! (30 points).

Create a decision tree, with all payoffs (net returns) and probabilities labeled. Solve the tree, labeling all decision and event nodes with payoffs. [Note from the last paragraph in the case that the “sell lease” option is only to be included in the bottom (do not test) part of the tree.] (30 points)

Answer these questions (5 points each):

1.a. What is the expected return for the optimal strategy prior to consideration of testing (get from bottom of tree or from a decision matrix)? b. Should global drill or sell the lease?

2.a. What is the optimal strategy when considering the possibility of testing? (Make sure to explain what you would do based on every decision node on the tree!)

b. What is the expected return associated with the optimal strategy? (This is the final solution to your tree - furthest left decision node.)

3.a. What is the EVPI? (Make sure to find the EVwPI first, and remember to only use the bottom of the tree to do these calculations!) b. Explain the meaning of the Expected Value of Perfect Information.

4.a. What is the EVSI? (This is the difference between the top and bottom of the tree, excluding the cost of the test.)

b. Explain the meaning of the Expected Value of Sample Information.

Note: You may install Treeplan from your Student CD (Moore and Weatherford text) or you may do this assignment by hand. Treeplan is an Excel add-on. If you use Treeplan, be sure to start your decision tree in Column B!