You are thinking of investing in a field that may have commercial amounts of oil

Question

You are thinking of investing in a field that may have commercial amounts of oil. Based on the existing data of the field you believe there is a 15% chance that if you drilled immediately you would find a commercial discovery. You also have the option of investing in more information, which would include more sample wells and data acquisition. You believe that there is an equally likely chance that this information will either double expected chances of finding a well, or inform you for certain that the area is not commercial. The additional information would cost $60MM. Drilling for production would cost $100MM. A normal commercial discovery would result in an NPV of $750MM after the original drilling and seismic costs. However, you know that a third of all commercial discoveries are major discoveries resulting in an NPV of $1,000MM after the original drilling and seismic costs.

Do you decide to invest in the project?
If you decide to invest, would you invest in more data acquisition?

Explanation / Answer

Expected value of project .05 *1,000 +.10 *750 +.85*(100)= 50 +75 +(85)= 40 so since expected value is positive you invest in the project.

Expected value of getting more information is (60) +.10*1,000 +.20 *750 +.70(100) = 120 which is greater than 40 so you get more information.

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