E370

9/27/2015
Week 06: Discrete vs
Continuous Variables
Part 2: Calculating Binomial
Probabilities
Success must be defined.
Number of trials must be determined.
The probability of success must be
known or estimated.
Sample space must be defined.

Necessary Information for the

Binomial
. . . drilled in areas deemed X P(X)
favorable strike oil. A company 0
has found 5 sites with favorable 1
conditions, that are widely 2
separated geographically, and
decides to drill at each site. 3
Lets create the probability 4
distribution for this variable. 5
In Excel, list the sample space for this
variable in a column.
We will use Excel and this command
to calculate probabilities:
=BINOM.DIST(x, n, , 0)

About 30% of wells . . .

 =BINOM.DIST(x, n, , 0) X P(X)
x is the number of successes of 0 =BINOM.DIST(
interest.
n is the number of trials. 1
is the probability of success. 2
0 means that we want the probability 3
of a single value, whatever x is.
Click on the cell immediately to the right 4
of the first value in the sample space. 5
Type in =BINOM.DIST(
Point to the cell to the left and click.
Type a comma , 5, 0.3, 0). Now,
highlight the cell you were working in,
and drag the handle down so that all
the probabilities for the sample space
have been calculated.

The Excel Command

 X Command P(X)
0 =BINOM.DIST(0,5,0.3,0) 0.1681
1 =BINOM.DIST(1,5,0.3,0) 0.3601
2 =BINOM.DIST(2,5,0.3,0) 0.3087
3 =BINOM.DIST(3,5,0.3,0) 0.1323
4 =BINOM.DIST(4,5,0.3,0) 0.0284
5 =BINOM.DIST(5,5,0.3,0) 0.0024

The Probability Distribution

 Oil Well Strikes
0.3602
0.3087

0.1681
0.1323

0.0284
0.0024

0 1 2 3 4 5
 Suppose you wanted to know the probability that
as many as 2 wells came in.
A minor adjustment in the Excel command:
=BINOM.DIST(X, n, , 1)
The 1 tells Excel to add the probabilities for all values up
to and including the x value you designate.
=BINOM.DIST(2, 5, 0.3, 1) = 0.8369
Combining this feature of Excel with our
knowledge of the requirements for valid
probability distributions makes for a very flexible
tool.

Calculating probabilities for more

than one value. . .
 0 1 2 3 4 5

0 1 2 3 4 5

0 1 2 3 4 5

A useful diagram . . .
and easy to sketch!
 Thecompany must have at least 2 strikes to
cover its costs. What is the probability that the
company will cover its costs or even make
money?

0 1 2 3 4 5

=1-BINOM.DIST(1,5,0.3,1) = 0.4718

Calculate the probabilities

 What is the probability that the company will
NOT cover its costs?
=BINOM.DIST(1,5,0.3,1) = 0.5282

0 1 2 3 4 5
 Whatis the probability that more than two but
no more than four wells come in?
=BINOM.DIST(4,5,0.3,1)BINOM.DIST(2,5,0.3,1)=
0.1607

0 1 2 3 4 5
A right tailed or interior option
=BINOM.DIST.RANGE(n, , x1, x2)
Calculates the cumulative probability of a range
including the probability of the limiting values.
What is the probability that more than two but no
more than four wells come in?
=BINOM.DIST(4,5,0.3,1)BINOM.DIST(2,5,0.3,1)=
0.1607
=BINOM.DIST.RANGE(5, 0.3, 3, 4)=0.1607

New from 2013