Calculating Expected Value of Oil Co. Offshore Drilling Bid

In summary, the expected value of the deal to the company is $0. This is based on the probabilities of winning the bid, striking oil, and the company's drilling costs.
  • #1
cronxeh
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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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  • #2
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.
 
  • #3
OK I think I got it

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

1. What is the expected value of an offshore drilling bid for an oil company?

The expected value of an offshore drilling bid for an oil company is the predicted monetary value that the company will gain from the drilling process. It takes into account factors such as the cost of the bid, the potential amount of oil that can be extracted, and the current market value of oil.

2. How is the expected value of an offshore drilling bid calculated?

The expected value of an offshore drilling bid is calculated by multiplying the probability of success (the likelihood of finding a profitable amount of oil) by the potential monetary gain and subtracting the cost of the bid. The formula for expected value is: (Probability of Success * Potential Gain) - Cost of Bid.

3. What factors influence the expected value of an offshore drilling bid?

There are several factors that can influence the expected value of an offshore drilling bid, including the cost of the bid, the potential amount of oil that can be extracted, the current market value of oil, the success rate of previous drilling projects in the same area, and any potential risks or obstacles that may impact the drilling process.

4. Can the expected value of an offshore drilling bid change over time?

Yes, the expected value of an offshore drilling bid can change over time. This is because factors that influence the expected value, such as the market value of oil and the success rate of previous drilling projects, can fluctuate. It is important for oil companies to regularly reassess and update their expected value calculations to account for any changes.

5. How can the expected value of an offshore drilling bid be used by an oil company?

The expected value of an offshore drilling bid can be used by an oil company to make informed decisions about whether to pursue a drilling project or not. If the expected value is positive, it indicates that the potential gains outweigh the cost of the bid and the project is likely to be profitable. However, if the expected value is negative, it may be more beneficial for the company to pass on the bid and allocate resources to other projects with a higher expected value.

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