Decision Analysis
Problem: Wildcat Industries is a small oil speculation company based in Alberta. They purchase tracts of land that larger oil companies dismiss as unpromising even though initial geological reports suggest may have oil. Then Wildcat does more sophisticated seismic analysis to determine if they should attempt to drill for oil. If oil is found, they can sell the land to one of the larger companies for a huge profit or they can extract the oil themselves. Wildcat recently bought various tracts of land in Manitoba. A geophysicist recently completed their seismic analysis, and they say there is a one in three chance that one tract of land has oil.
Wildcat Industries must now decide what to do. They can drill for oil at a cost of $250,000. If land is dry (i.e. no oil), then they lose the entire investment. But if a well is found, they can sell the land for a large profit, or they extract the oil themselves. If a large oil well is found, they’ll sell the property for a projected $1.5 million. If a small oil well is found, they plan to extract the oil quickly themselves at a cost of $25 per barrel and sell the oil for $45 per barrel. A small oil well has around 50,000 barrels. If there is oil, there is a 50% chance it is a small well.
Alternatively, another oil speculator has learned about the geophysicists report and is offering to buy the land for $90,000.
Step 1: Read the problem
Step 2: Create payoff and opportunity loss tables for the problem.
Step 3: Determine the optimal decision based on all of the decision methods:
· Maximax
· Maximin
· Expected monetary value
· Expected opportunity loss
· Return to risk ratio
Step 4: Based on your work in Step 3, decide what you believe is the optimal decision and explain your reasoning.
Step 5: Create a report of your work for your manager. The report needs to include the following:
· A clear statement of the suggested decision and the reasoning behind your decision. Your reasoning must rely on the decision methods from Step 3 (that is, your personal opinion is not appropriate) and an explanation of why you valued certain decision methods over others.
o Make sure to talk about multiple decision methods and not just focus on one. That is, don’t just say “EMV is the best”. Instead, explain why EMV is the best and include what the other decision methods indicate as well.
· At the END of your report, include three tables that are properly labeled with these names
o Table 1: Payoff Table
o Table 2: Opportunity Loss Table
o Table 3: Summary of results of decision analysis
Table 3 would looks something like this but with “Choice 1” changed to the actual choice in the problem.
Decision method
Optimal choice
Value for [Choice 1]
Value for [Choice 2]
Value for [Choice 3] (if needed)
Maximax
[put in Choice not value]
Maximin
Expected monetary value
Expected opportunity loss
Return to risk ratio
