For example at the uppermost event fork representing

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: lar values by probabilities, as in a decision tree analysis using expected values, multiply the preferences by the probabilities. So, at each event fork take a weighted-average of the preferences, where the weights are the probabilities. For example, at the uppermost event fork representing “oil-no oil”, the preference is 0.83 (0.85*0.93+15*0). The preference is written under the fork in green in figure 5.10. 3. For each act fork, the decision-maker or analyst then selects the act with the highest preference. For example, the upper most decision fork in figure 5.10, the choice is between “drill” with a preference of 0.83 and “don’t drill” with a preference of 0.60, so the choice is to drill. The preference of the act chosen is written in pink at the base of each act fork in figure 5.10. The act not chosen is scored off and this is shown by the double bar in figure 5.10. 4. Continue backwards through the tree, repeating steps 2 and 3 until the base of the tree is reached. For instance, the preference of the decision to take the test is 0.74 (0.60*0.83+0.4*0.6), while the preference not to take the test is 0.68. The analysis using preference theory therefore indicates the decision-maker’s best strategy is to take the test and, if it gives a favourable result, drill; if it produces an unfavourable result, do not drill. With EMV, the decision-maker would be advised to drill immediately. The preference theory approach takes into account the executive’s natural conservatism and tells him to take the seismic test first and drill only if it is favourable. The seismic test then is a form of “insurance policy”, which is good for the conservative decisionmaker in this case, but not worth its price to the averages-player (who would always choose the decision alternative that would maximise their EMV). 91 $400,000 Oil 0.85 $400,000 Drill $-100,000 $340,000 Test favourable 0.6 No oil 0.15 $0 Don’t drill Acquire seismic data $-30,000 Test unfavourable 0.4 $100,000 Oil 0.1 Drill $-100,000 $400,000 $400, 000 $40,000 $0 No oil 0.9 Don’t drill $100,000 Oil $430,000 0.55 Don’t acquire seismic data $400,000 KEY Drill $250,000 No oil $30,000 0.45 $-100,000 Act fork Event fork Don’t drill Best strategy Green numbers EMV of decision alternative Figure 5.7: Analysis using EMV 92 $130,000 $244,000 (0.6*340000+100000*0.4) Acquire seismic data Don’t acquire seismic data $250,000 Figure 5.8: Test results eliminated 1 0.6 Preference 0.5 0 $0 $100000 $200000 Net Liquid Assets Figure 5.9: The decision-maker’s preference curve 93 $300000 $400000 $400,000,0.98 Oil 0.85 Drill $-100,000 Test favourable 0.6 $400,000 0.83 $0,0.0 No oil 0.15 0.83 Don’t drill Acquire seismic data $-30,000 0.74 Drill $-100,000 Test unfavourable 0.4 $100,000,0.6 Oil 0.1 $400,000,0.98 $400, 000 0.1 No oil 0.9 0.60 Don’t drill $0,0.0 $100,000,0.6 0.74 Oil 0.55 $430,000,1.00 $400,000 Don’t acquire seismic data Drill $-100,000 0.67 No oil 0.45 $30,000,0.27 0.68 KEY Don...
View Full Document

Ask a homework question - tutors are online