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    Petro-Co: Solving with the conditional probability formula

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    Petro-Co must determine whether they should drill an exploratory well. It costs $200,000 to drill, and if oil is discovered, the value (net profit) is estimate to be $800,000. If oil is not discovered, the cost will be just a loss for Petro-Co. Currently there is a 45% chance that drilling a well will lead to oil discovery.

    1. Use the minimum regret criterion to decide whether to drill or not to drill.
    2. What is the best choice Petro-Co should go for using the expected value of this major project?
    3. What is the best decision based on the EOL?
    4. What is the expected value of perfect information?
    5. Petro Co is considering conducting a seismic survey which costs $10,350, to see what the underground conditions are like. The survey history shows that
     There is a 96% chance of a favorable wave transmission, given that there is an oil discovery.
     There is a 84% chance of an unfavorable wave transmission, given that there is a dry well.
    According to the given data, find the posterior probabilities.
    6. What is the value of sample information?
    7. Examine how your decision might change with different oil discovery probabilities. Let p denote the probability of a dry well and 1-p denote the probability of well discovery. What are the ranges of p that affect your decision? Solve this part as a risk neutral decision maker without any perfect or sample information.

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    Solution Summary

    We will start with the State of Nature table and then we will make the Regret Table.
    Regret table is when we subtract the values on each column from the maximum value per column.
    Then we take the maximum value on each row and compare the two values corresponding to Drill and Not drill.