Your oil company must decide whether to drill a well at a cost of $500,000 on a
ID: 1176905 • Letter: Y
Question
Your oil company must decide whether to drill a well at a cost of $500,000 on a piece of leased property or to sell the lease for $1,000,000. The lease was purchased in 2003 for $120,000 and is on a prospect in a fairly well established field. Thus far, 65 wells have been drilled in the field. The results of drilling are 15 dry holes, 12 gas producers, 18 oil wells, and 20 wells producing both oil and gas. The present worth of all future production for each type of well is as follows: gas, $2,550,000; oil, $4,500,000; and both gas and oil, $3,600,000. If the decision is to be based on maximum expected value, what should be done?
My thoughts:
My original rationality is to sell the lease. Why? Well add up the future production of all the wells ($10,650,000), divide that by the number of wells drilled (65) and you get total $163,846 profit per well. What this doesnt reflect is past production from those wells, but that data was not given- nor were any timelines. However, given the fact that $163,846 is FAR off from clearing the $500,000 cost to drill the well, OR even the $1,000,000 offered to sell the lease; it is more beneficial to sell the lease for the $1M.
The one cog in the wheel IMO, is= The question doesn't specify if were selling the lease for the ENTIRE field, or for just that one well... If its for the ENTIRE field then HECK NO. In that case, choose NEITHER, and drill no well, because the extra well isnt worth it- but the whole field is worth $10,650,000 which is > $1,000,000.... So yeah, I'm not even throwing out a concrete answer because the question isnt specific at all.
Explanation / Answer
Sell the lease to liabilities attached to it which indeed will increase the cost later.
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