The Mobile Oil company has recently acquired oil rights to a new potential source of natural oil in Alaska. The current market value of these rights is $90,000 (Company can sell the project for $90,000). If there is natural oil at the site, it is estimated to be worth $800,000; however, the company would have to pay $100,000 in drilling costs to extract the oil. The company believes there is a 0.25 probability that the proposed drilling site actually would hit the natural oil reserve. Alternatively, the company can pay $30,000 to first carry out a seismic survey at the proposed drilling site. The probability of a favorable seismic survey is 60% and unfavorable seismic survey is 40%. If company under seismic favorable result decides to drill, probability of the hit oil is 80% and dry hole is 20%. But if seismic report is unfavorable, probability of hit oil is 10% and dry hole is 90 %. If seismic report came unfavorable, selling value of the project will drop from $90,000 to $50,000. If seismic report came favorable, selling value of the project will increase from $90,000 to $110,000.
a. Construct a decision tree for this problem.
b. What is the optimal decision strategy using the EMV criterion? Highlight all the branches for optimal solution.