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Kaplan
Value of imperfect Information Eg:Working from right to left:
EV(A) = (41.30% × $200,000) – $10,000 drilling costs = $72,600.
The decision at ‘C’ should be to drill, as this generates higher benefits
than not drilling.
EV(B) = (0.65% × $200,000) – $10,000 drilling costs = –$8,700. The
decision at ‘D’ should be not to drill.
EV(E) = 0.23 × $72,600 = $16,698. This is the expected value of profits
if a geologist is employed and exceeds the EV of profits if she is not
employed.
Expected Value of Imperfect Information = $16,698 – $10,000 = $6,698.
Since this is less than the cost of buying the information ($7,000), we
should not employ the geologist at point ‘F’.Sorry, I couldn’t attach the decision tree diagram here. However, EV at Decision point E, I don’t understand why the EV multiples only 0.23 * $72,600 but not 0.77 “poor prospects” part? Please help me understand.
As explained in the lectures on this, you cannot now be expected to draw a decision tree in the exam (although you can be tested that you understand decision trees).
The answer to part (b) must start with the results from the geologist, because what she says will affect the decision about whether or not to drill.
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