25. Decision trees (S10.3) Your midrange guess as to the amount of oil in a prospective field...

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25. Decision trees (S10.3) Your midrange guess as to the amount of oil in a prospective field is 10 million barrels, but there is a 50% chance that the amount of oil is 15 million barrels and a 50% chance of 5 million barrels. If the actual amount of oil is 15 million barrels, the present value of the cash flows from drilling will be $8 million. If the amount is only 5 million barrels, the present value will be only $2 million. It costs $3 million to drill the well. Suppose that a seismic test costing $100,000 can immediately verify the amount of oil under the ground. Is it worth paying for the test? Use a decision tree to justify your answer.

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Principles Of Corporate Finance

ISBN: 9781264080946

14th Edition

Authors: Richard Brealey, Stewart Myers, Franklin Allen, Alex Edmans

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