Question
Assume you are the owner of an oil firm and that you are about to drill the first well. Although the amount of revenue generated
Assume you are the owner of an oil firm and that you are about to drill the first well. Although the amount of revenue generated from the well is dependent on the amount of oil and gas in place, your geologist has told you there are five potential production outcomes, each with a probability as follows:
Potential Outcome i | Quantity (Barrels) Produced | Probability of Outcome i |
1 | 200,000 | .15 |
2 | 350,000 | .15 |
3 | 850,000 | .35 |
4 | 950,000 | .30 |
5 | 1,500,000 | .05 |
Now, we can express the average or expected return (r ) for this asset as:
where, pbtyi = the probability potential outcome (or return) i occurs qi = the quantity of oil produced under potential outcome i p = the price (per barrel) of oil
Given an average price of oil of $3 per barrel throughout the life of the producing well, which of the following is the expected total revenue from the oil produced by this well?
A. $740,000
B. $2,200,000
C. $4,400,000
D. $11,550,000
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