Oyster Oil Company has the option to pursue leases in the following two areas

A) An onshore field where: A well costs $2 million to drill and complete, and an additional $500,000 to connect to a pipeline Operating expenses are 10% of the initial capital expense ($250k/year) and royalty is 10% Oil rate is given by stb = 100000 exp(-0.4t) Where t is in years and Q is stb/day and, for simplicity, is assumed constant for the whole year. Porosity, , has an average value of 12% with a standard deviation of 3% A well is considered a dry hole if porosity is less than 10%. The formation is cored while drilling and the well is not connected to the pipeline if it considered a dry hole

B) An onshore field where : A well costs $3 million to drill and complete, and an additional $1 million to connect to a pipeline Operating expenses are 25% of the initial capital expense ($4M/yr) and royalty is 20% If oil is found, production will follow: stb 30000 exp(-0.4t) Where t is in years and Q is stb/day and, for simplicity, is assumed constant for the whole year. Porosity, , has an average value of 20% with a standard deviation of 10% A well is considered a dry hole if porosity is less than 10%. The formation is cored while drilling and the well is not connected to the pipeline if it considered a dry hole Oil price is $50/stb and the discount rate is 10%. The well life is expected to be 10 years

1) Draw a decision tree which includes both scenarios and label each node For the two scenarios, compute: The NPV of the expected production from the two scenarios for the first 10 years of production The EMV of the two scenarios The EPI of the two scenarios

2) The performance index of the two scenarios A and B

3) Which scenario would you pick? How much would you be willing to pay for a lease for each scenario? Would your decision change if you know oil price will drop to $40/stb in year 4 and stay at $40 for the remainder of the 10 years?