Shamrock Oil has decided to rely on utility theory to assist in the decision concerning the oil…
Shamrock Oil has decided to rely on utility theory to assist in the decision concerning the oil field. The following table describes its utility function; all monetary values are in thousands of dollars:
(a) Redo Problem 37 using this information.
(b) How can you best describe Shamrock Oil’s attitude toward risk? Justify your answer.
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Shamrock Oil owns a parcel of land that has the potential to be an underground oil field. It will cost $500,000 to drill for oil. If oil does exist on the land, Shamrock will realize a payoff of $4,000,000 (not including drilling costs). With current information, Shamrock estimates that there is a 0.2 probability that oil is present on the site. Shamrock also has the option of selling the land as is for $400,000, without further information about the likelihood of oil being present. A third option is to perform geological tests at the site, which would cost $100,000. There is a 30% chance that the test results will be positive, after which Shamrock can sell the land for $650,000 or drill the land, with a 0.65 probability that oil exists. If the test results are negative, Shamrock can sell the land for $50,000 or drill the land, with a 0.05 probability that oil exists. Using a decision tree, recommend a course of action for Shamrock Oil.
