Southern Gas Company (SGC) is preparing to make a bid for oil and gas leasing rights in a newly opened drilling area in the Gulf of Mexico. SGC is trying to decide whether to place a high bid of $16 million or a low bid of $7 million. SGC, expects to be bidding against its major competitor Western Gas Corporation (WGC) and predicts WGC to place a bid of $10 million with a probability of 0.4 or a bid of $6 million with probability 0.6. Geological data collected at the drilling site indicates a 0.15 probability of the reserves at the site being large, a 0.35 probability of being average, and a 0.5 probability of being unusable. A large or average reserve would most likely represent a net asset value of $120 million or $28 million, respectively, after all drilling and extraction costs are paid. The company that wins the bid will drill an exploration well at the site for a cost of $5 million. a. Develop a decision tree for this problem.
b. What is the optimal decision according to the EMV criterion?
c. Create a strategy table showing how the optimal decision would change if the probability of the NGC bidding $10 million varies from 0% to 100% in steps of 10%.
d. Create a strategy table showing how the optimal decision would change if the net asset value of a large reserve varies from $100 million to $140 million in $5 million increments and the net asset value of an average reserve varies from $20 million to $36 million in increments of $2 million.