ABSTRACT
Example 9.5 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 the oil wells using the company's existing facilities, (2) to drill the oil wells using new facilities and (3) to subcontract the drilling to a number of smaller companies. The results from these alternatives are given as follows:
The cost of preparing the contract proposal 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. Solution: As shown in Figure 9.2, the oil company should make the bid because this will result in an expected payoff value of $143.2 million.
