MINI-ASSIGNMENT 3

Southern Gas Company (SGC) is preparing to make a bid for oil and gas leasing rights in
a newly opened drilling area in the Gulf of Mexico. SGC is trying to decide whether to
place a high bid of $16 million or a low bid of $7 million. SGC expects to be bidding
against their major competitor, Northern Gas Company (NGC) and predicts NGC to place
a bid of $10 million with a probability of 0.4 or a bid of $6 million with a probability of
0.6. Geological data collected at the drilling site indicates a 0.15 probability of the
reserves at the site being large, a 0.35 probability of being average, and a 0.5 probability
of being unusable. A large or average reserve would most likely represent a net asset
value of $120 million or $28 million, respectively, after all drilling and extraction costs
are paid. The company that wins the bid will drill an exploration well at the site for a
cost of $5 million. Management has come up with the following decision tree (next
page):

0.15
Large
99
120
0.4
NGC bids 10

99

0.35
Avg
7

-21

6.8

28

0.5
Unusable
-21
SGC Bids 16
0

0
6.8

-21

0.15
Large
99
120
0.6
NGC bids 6

99

0.35
Avg
7

-21

6.8

28

0.5
Unusable
-21
0

-21

2
9.48

0.15
Large
0
0
0.4
NGC bids 10

0.35
Avg
0

0.5
Unusable
0
SGC Bids 7
0

0
9.48

0.15
Large
108
120
0.6
NGC bids 6

108

0.35
Avg
16

-12

15.8

28

16

0.5
Unusable
-12
0

-12

Questions:
a) Solve the remainder of the tree and find the Expected Value without Perfect Information.
b) Determine the value of perfect information regarding whether NGC will bid $10 million or $6 million.