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Risk: expected value and chance of success (view source)
Revision as of 16:37, 23 June 2014
, 16:37, 23 June 2014→Decision tree analysis
Theoretically, the basic decision rule is to always choose the branch having the highest expected value. In practice, however, capital-constrained companies often select a less desirable option due to capital requirements of a higher EV alternative.
Theoretically, the basic decision rule is to always choose the branch having the highest expected value. In practice, however, capital-constrained companies often select a less desirable option due to capital requirements of a higher EV alternative.
[[File:Expected-value-and-chance-of-success_fig1.png|thumb|300px|{{figure_number|1}}Development well decision tree problem.]]
[[File:Expected-value-and-chance-of-success_fig1.png|thumb|400px|{{figure_number|1}}Development well decision tree problem.]]
[[:file:Expected-value-and-chance-of-success_fig1.png|Figure 1]] shows a decision tree for a simple development well problem. The problem here is whether to drill a well at the edge of a developing oil field or to shoot a seismic line first to try to determine whether the location may be structurally low and wet and thus move the drill site to the most favorable location. There is also uncertainty about [[reservoir quality]], which cannot be resolved without drilling. The costs in this example are as follows: cost of seismic ($100,000), cost of deferring production to allow time to shoot, process, and interpret seismic ($25,000), cost of dry hole ($400,000), and mean present value of producing well ($800,000, including drilling costs). An analysis of this problem shows two options:
[[:file:Expected-value-and-chance-of-success_fig1.png|Figure 1]] shows a decision tree for a simple development well problem. The problem here is whether to drill a well at the edge of a developing oil field or to shoot a seismic line first to try to determine whether the location may be structurally low and wet and thus move the drill site to the most favorable location. There is also uncertainty about [[reservoir quality]], which cannot be resolved without drilling. The costs in this example are as follows: cost of seismic ($100,000), cost of deferring production to allow time to shoot, process, and interpret seismic ($25,000), cost of dry hole ($400,000), and mean present value of producing well ($800,000, including drilling costs). An analysis of this problem shows two options: