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# hw_3_solution - Homework#3 Decision Analysis and Revenue...

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Homework #3 Decision Analysis and Revenue Management BUAD311- Operations Management Fall 2011 1. (15 points) An energy company has developed a new hydraulic fracturing technology that allows it to extract natural gas from deep underground. The company has identified a potential extraction site, and has offered the landowner \$150,000 for the exploration rights to natural gas and the option for future development. This option, if exercised, is worth an additional \$1,800,000 to the landowner, but this will occur only if natural gas is discovered during the exploration phase. The landowner believes that the energy company’s interest in the site is a good indication that gas is present, and is tempted to develop the field herself. To do so, she must hire local experts in natural gas exploration and development. The initial cost of such contract is \$300,000, regardless of whether or not gas is found on the site. However, if gas is discovered, the landowner can generate a profit of \$2,500,000. Finally, the landowner estimates the probability of finding gas on the site to be 60%. a. (5 points) Construct a decision tree for this problem. b. (10 points) Identify the strategy that maximizes the landowner’s expected profit. Expected payoff for taking offer: 0.6*1.95+0.4*0.15 = 1.23 Million Expected payoff for DIY: 0.6*2.2+0.4*(-0.3) = 1.2 Million Optimal strategy is to take offer.

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hw_3_solution - Homework#3 Decision Analysis and Revenue...

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