1.

Bighorn Oil Company has leased the drilling rights on a large parcel of land in Wyoming that
may or may not contain an oil reserve. A competitor has offered to lease the land for
$200,000 cash in return for drilling rights and all rights to any oil that might be found. The
offer will expire in three days. If Bighorn does not take the deal, it will be faced with the
decision of whether to drill for oil on its own. Drilling costs are projected to be $400,000. The
company feels that there are four possible outcomes from drilling
1) dry hole (no oil or natural gas)
2) natural gas
3) natural gas and some oil
4) oil only

If drilling yields a dry hole, the land will be basically worthless, because it is located in the
Badlands of Wyoming. If natural gas is discovered, Bighorn will recover only its drilling costs.
If natural gas and some oil is discovered, revenue is projected to be $800,000. Finally, if only
oil is discovered, revenues will be $1,600,000. If Bighorn decides to drill. The company has
subjectively assessed the probability of each of the four possible outcomes as follows:

Using Decision-tree analysis, help the company to make a decision

2. An oil drilling company is considering bidding on a $110 million contract for drilling oil wells.
The company estimates that it has a 60% chance of winning the contract at this bid.
If the company wins the contract, it will have three alternatives.
1) To drill oil wells using the company’s existing facilities
2) To drill the oil well using new facilities
3) To subcontract the drilling to a number of smaller companies.
The results from these alternatives are given as follows:

Outcomes Profit ( $ million)

Using existing facility
Success 0.3 600
Moderate 0.6 300
Failure 0.1 -100
Using new facility
Success 0.5 300
Moderate 0.3 200
Failure 0.2 -40
Subcontract
Moderate 1 250
The cost of preparing the contract is $ 2 million. If the company does not make a bid, it will
invest in an alternative venture with a guaranteed profit of 30$ million. Construct a
sequential decision tree for this decision situation and determine if the company should
make a bid.