Quantitative Analysis for Management – III

Indian Institute of Management Lucknow, Noida Campus

Submitted to - Prof. B.K. Mohanty

Submitted by:

Harshit Gupta PGPWE17022

Raghu Mallegowda PGPWE17042

Rajiv Chowdhury PGPWE17044

Executive Summary:

Mr. I.M. Teliani is the owner of a tract of land next to the Ankleshwar oilfields in Gujarat. ONGC

approached him to buy his land with an offer of Rs 60 lacs and to add on to this if oil was found on the

tract of the land then the company would further pay him Rs 600 lacs more. Now Mr. Teliani was left

with the below options:

1) Go for oil exploration himself which will cost him Rs 100 lacs, but if after exploration oil was

found he will make an overall profit of Rs 2000 lacs

2) Approach oil exploration company Oil Finders Ltd. who would be charging Rs 2 lacs for detecting

soundings of gas

If no gas is found chances are there that ONGC might withdraw the entire offer so Mr. Teliani is now at a

crossroad to take a decision on whether to take the offer of ONGC or go for the oil exploration himself

and then take the offer of ONGC or to directly reject the offer of ONGC and go for oil exploration

himself.

Introduction:

Mr. I.M. Teliani had got an exciting offer from ONGC for one of his tract of land. They made an offer of

Rs 60 lacs and to add on to this if oil was found on the tract of the land then the company would further

pay him Rs 600 lacs more. If he wishes to go all alone and explore for oil then it is going to incur him Rs

100 lacs, but if after exploration oil was found then it would make him richer by Rs 2000 lacs. Mr. Teliani

also came to know from a source in ONGC that there is a probability of 0.6 of finding oil in his field.

Oil Finders Ltd., a consulting geologist firm which specializes in taking soundings for oil explorations

approached Mr. Teliani with a quote of Rs 2 lacs in which they would do the exploration of soundings of
gas on his tract of land. But Teliani was a bit skeptical about the chances of gas being reported by such

consulting firms. So Teliani was in a quandary about what to do.

Historical data suggests that if there is oil the chances of presence of gas would be 70% but the

interesting part is there is also a 10% chance of finding gas even if the field is dry. It is quite obvious that

if the soundings reveal no gas then ONGC is going to withdraw its offer. So Mr. Teliani had to decide

whether to directly sell the land to ONGC or keep the tract of land with him and carry out the

exploration all by himself or shell out Rs 2 lacs on soundings and then take the final decision.

As a student of management we will try to use the Bayes’ decision rule along with the decision analysis

to arrive at a final decision. The decision analysis organizes the problem and to the options it provides

for the criterion to use for making the decisions. We will then be able to choose the criterion that feels

right to us. Then we will look at whether it might be worthwhile to do the oil exploration soundings and,

if so, how to best use its information. After that we will get into the nitty gritty of carefully analyzing the

problem.

Data Requirements

To deliver the design and solve the Oily waters problem, consulting team needs the below data sets

Basic Data

1. The Offer made by ONGC

a. Initial offer : Rs 60 lakh (Given)

b. Post Oil Discovery : Rs 600 lakh (Given)

2. Cost of Engaging oil finder Ltd : Rs 2 lakh (Given)

3. Cost of Own Exploration : Rs 100 lakh (Given)

4. Profit if oil is found : Rs 2000 lakh (Given)

5. Total Revenue if oil is found : Rs 2100 lakh (Derived)

6. Probability of finding oil without sounding : 60% (Given)

7. Probability of not finding oil without sounding : 40% (Derived))

8. Probability of gas when oil is found : 70% (Given)

9. Probability of no gas when oil is found : 30% (Derived)

10. Probability of gas when no oil is found : 10% (Given)

11. Probability of no gas when no oil is found : 90% (derived)

12. Probability of oil when gas is found : 91% (Derived using Bayes theorem )

13. Probability of no oil when gas is found : 9%% (Derived using Bayes theorem)

14. Probability of oil when no gas is found : 33% (Derived using Bayes theorem)

15. Probability of no oil when no oil is found : 67% (Derived using Bayes theorem)

16. Probability of finding gas : 46% (Derived)

17. Probability of not finding gas : 54% (Derived))

Calculations

Bayes theorem

P(Oil/Gas) = P(Gas/Oil)*P(Oil)/{P(Gas/Oil)*P(Oil)+P(Gas/No Oil)*P(No Oil)}

P(No Oil/Gas) = 1- P(Oil/Gas

P(Oil/No Gas)= P(No Gas/Oil)*P(Oil)/{P(No Gas/Oil)*P(Oil)+P(No Gas/No Oil)*P(No Oil)}

P(No Oil/No Gas)= 1- P(Oil/No Gas)

P(Gas)= P(Gas/Oil)*P(Oil)+P(Gas/No Oil)*P(No Oil)

P(No Gas) = 1- P(Gas)

Implementation Phase

Implementation involves two critical decisions with each having their own outcomes. The first critical

decision whether to hire services of oil finders or not. If hired, there will be two outcomes- detection of

gas or non-detection. The second critical decision is to explore on own or to sell. Explore option is open

when either is either found or not found or even when oil finders are not hired. But selling option is

open when oil finders are not engaged or when gas is found. If the decision is to go ahead to explore on

own option, then there will be two outcomes- Oil may be found or oil may not be found. The various

scenarios that emerge because of two decisions at critical juncture is provided in the decision tree

below:
 DECISION TREE

0.91
Oil Discovered
1998
Explore 2100 1998

-100 1809 0.09

No Oil
0.46 -102
Gas 0 -102

0 1809 0.91
Oil Discovered
658
Sell 600 658

60 604 0.09
No Oil
Oil Finders 58
0 58
-2 1151.28
0.33
Oil Discovered
1998
+P(Gas/No Oil)*P(No Oil)} Explore 2100 1998

-100 591 0.67

0.54 No Oil
*P(Oil)+P(No Gas/No Oil)*P(No Oil)} No Gas -102
0 -102
0 591

Cannot sell
1160 -2
0 -2

0.6
Oil Discovered
2000
Explore 2100 2000

-100 1160 0.4

No Oil
-100
No Oil Finders 0 -100

0 1160 0.6
Oil Discovered
660
Sell 600 660

60 420 0.4
No Oil
60
0 60
Financial Deliverables.

The Right hand side of the provided the payoff for outcomes as a result of two critical decision discussed above. The payoffs range from loss Rs

102 lakhs to profit of Rs2000 lakhs.

The net payoff for each of the decisions are was calculated based on the probability of each event and same is provided at the junction of

event/decision branches in the decision tree.

The net payoff is slightly higher when oil finders are not engaged compared to when oil finders are engaged (Rs 1160 lakh vs Rs 1151 lakhs). The

difference is not very significant.

Basis above, if the oil finder ltd is not engaged, then net payoff will be more when the exploration is undertaken on own rather than selling (Rs

1160 lakh vs Rs 420 lakh).

The payoff is maximum Rs 2000 lakhs when oil is found when exploration undertaken on own without hiring the services of Oil Finders Ltd for

gas detection.
Conclusion

The net payoff is more influenced by the second critical decision which is whether to explore on own or sell the tract of land to ONGC. The first

critical decision is not having significant impact on the net payoffs possibly due to low cost of hiring Oil Finder Ltd. The second critical decision

irrespective of whether you hire the oil finders or not is significantly higher option of selling the land to ONGC. Therefore, it is our considered

view that Mr. I.M. Teliani should undertake exploration on his own without or without going for gas detection hiring the services of Oil Finders

Ltd.