Texas Oil owns a parcel of land that has the potential for containing much oil, some oil, or no oil underground. The company needs to decide whether or not to drill on this parcel. The payoffs are as follows in millions of dollars:

Texas Oil can do a geological test that costs $ 100,000 to determine the likelihood of finding oil underground. The results of the test can be positive, undecided, or negative with the probability of each being 0.12, 0.31, and 0.57 respectively. If the geological test comes back positive, the probabilities for underground oil are as follows:
Much oil = 0.75
Some oil = 0.05
No oil = 0.20
If the geological test comes back undecided, the probabilities for underground oil are as follows:
Much oil = 0.02
Some oil = 0.89
No oil = 0.09
If the geological test comes back negative, the probabilities for underground oil are as follows:
Much oil = 0.01
Some oil = 0.03
No oil = 0.96
a. Choose the best drilling option for Texas Oil under these conditions.
b. What is the most that Texas Oil should pay for the geological test?

Transcribed Image Text:

Option Drill Don't drill Much Oil $2 S0 Underground Oil Some Oil $0.7 $0 No Oil $0