Maximizes landowners expected net earnings from opportunity

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Reference no: EM13338020

A local energy provider offers a landowner $180,000 for theexploration rights to natural gas on a certain site and the optionfor future development. This option, if exercised, is worth anadditional $1,800,000 to the landowner, but this will occur only ifnatural gas is discovered during the exploration phase. Thelandowner, believing that the energy company’s interest inthe site is a good indication that gas is present, is tempted todevelop the field herself. To do so, she must contract with localexperts in natural gas exploration and development. The initialcost for such a contract is $300,000, which is lost forever if nogas is found on the site. If gas is discovered, however, thelandowner expects to earn a net profit of $6,000,000. Finally, thelandowner estimates the probability of finding gas on this site tobe 60%.

a. Formulate a payoff table that specifies the landowner’spayoff (in dollars) associated with each possible decision and eachoutcome with respect to finding natural gas on the site.

b. Use PrecisionTree to identify the strategy that maximizes the landowner’s expected net earnings from this opportunity.

Reference no: EM13338020

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