The following example illustrates both emv and the

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Unformatted text preview: r can lead to big advances in the eventual solution to a problem.” (Goodwin and Wright, 1991 p115) Wells (1982) believes users find decision trees a clear way of understanding the issues. The following example illustrates both EMV and the decision tree concepts. The example is taken from Galli et al. (1999). Suppose that an exploration well led to the discovery of a field that could have large or small reserves. In the first case, installing a large platform is optimal, while installing a small one is more appropriate in the second case. Installing the wrong size platform is an expensive mistake. The engineer in charge of the project wants to obtain more information before making a decision, but this is costly. What is the best decision? Figure 5.4 shows the decision tree corresponding to this situation. Large field 0.4 Large platform 134 Small platform Appraisal/small or large platform KEY Small field 0.6 Large field 0.4 170 110 150 138 Small field 0.6 130 Large field 0.4 165 Appraisal 141 Act fork Small field 0.6 Event fork 125 Green numbers EMV of decision alternative Figure 5.4: An example of a decision tree (the figure under the decision node is the value of the branch)(source: adapted from Galli et al., 1999) 82 Decisions are represented by squares sometimes referred to as act forks (for example, Hammond, 1967). The branches emanating from these correspond to possible decisions (for example, installing a large platform immediately, installing a small one, or getting additional information). Circles represent uncertain (chance) events (in this case, large reserves with a probability of 60% or small ones with a probability of 40%). These are sometimes referred to as event forks (for example, Hammond, 1967). At the end of each branch (or terminal node), the final NPV is marked. For example, installing a large platform when the reserves prove to be large generates an NPV on 170 if carried out immediately compared to an NPV of 165 if additional information is obtained. To compare the decisions, the EMV for each decision alternative is calculated at each circular node (event fork). For the top branch, for example, it is 170*0.4+110*0.6=134. Because the EMVs at the other two nodes are 138 and 141, respectively, the best decision is to carry out additional drilling before choosing the size of the platform. (Note, calculations are carried out from the terminal branches and are “folded back” to the trunk.) A large number of practical applications of these two concepts have been published over the years. For example, Uliva (1987) used the decision tree and EMV concepts to help the U.S. postal service to decide on whether to continue with the nine-digit zip code for business users. The analysis was designed to compare the monetary returns that might result from the use of various types of automatic sorting equipment either with or without the code. The author reported that the approach helped the decisionmakers: “…to think creatively about the problem and to generate options.”. (Goodwin and Wright, 1991 p111) Madd...
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