Calculating Expected Value of Oil Co. Offshore Drilling Bid

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SUMMARY

The expected value of the oil company's offshore drilling bid is calculated to be $0. The company has a 40% chance of winning the bid, which costs $1 million, and a 33.33% chance of finding oil worth $6 million. However, the total expected profit and loss calculations yield a net expected value of zero, as the potential profits and losses balance each other out. The calculations are confirmed by the decision tree method, leading to the conclusion that the bid does not provide a favorable expected value for the company.

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An oil company submits a bid of $1 million on an offshore area that the government is releasing for drilling. The company will win the bid and be awarded exclusive rights to the area with probability of 0.4. If awarded the bid, the company will drill and will find oil worth $6 million with the probability 1/3, otherwise the hole will be dry and yield nothing. The company's drilling costs are $1 million. Find the expected value of the deal to the company


OK I figure P(Winning the bid)=0.4 P(Losing the bid)=0.6 P(Striking Oil)=1/3 P(No Oil)=2/3 From decision tree I constructed, I figure

P(Making Profit of $6mil - $1mil for drilling - $1mil for bid = $4mil profit)=(0.4)*1/3=4/30 ~= 13.33%

P(Loss of $1mil for bid + $1mil for drilling = $2 million)=(0.4)*2/3 = 8/30 ~= 26.67%

P(Losing the bid, but no loss of money)=0.6 = 60%

Now my question is.. is this correct? the book has answer as '0' for some reason

I've summed up total probabilities (13.33+26.67+60=100) so I think I got it right, where am I getting it wrong?
 
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cronxeh said:
Now my question is.. is this correct? the book has answer as '0' for some reason

You didn't give the answer in your post! You gave the probabilities, but not the expected value.
 
OK I think I got it

(-$2mil)*(8/30) + (+$4mil)*(4/30) = -16/30 mil + 16/30 mil = 0
 

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