A landowner in Texas is offered $250,000 for the exploration rights to oil on her...
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A landowner in Texas is offered $250,000 for the exploration rights to oil on her land, along with a 25% royalty on the future profits if oil is discovered. The landowner is also tempted to develop the field herself, believing that the interest in her land is a good indication that oil is present. In that case, she will have to contract a local drilling company to drill an exploratory well on her own. The cost for such a well is $1,000,000, which is lost forever if no oil is found. If oil is discovered, however, the landowner expects to earn future profits of $7,500,000. Finally, the landowner estimates (with the help of her geologist friend) the probability of finding oil on this site to be 35%.
What should the landowner do?
a. She should develop herself as the EMV of developing herself is 1,625,000, which is higher than the EMV of selling.
b. She should sell as the EMV of selling is 906,250, which is higher than the EMV of developing herself.
c. She is indifferent between the two alternatives.
d. She should sell as the EMV of developing is less than the cost of $1,000,000.
A landowner in Texas is offered $250,000 for the exploration rights to oil on her land, along with a 25% royalty on the future profits if oil is discovered. The landowner is also tempted to develop the field herself, believing that the interest in her land is a good indication that oil is present. In that case, she will have to contract a local drilling company to drill an exploratory well on her own. The cost for such a well is $1,000,000, which is lost forever if no oil is found. If oil is discovered, however, the landowner expects to earn future profits of $7,500,000. Finally, the landowner estimates (with the help of her geologist friend) the probability of finding oil on this site to be 35%.
What should the landowner do?
| a. | She should develop herself as the EMV of developing herself is 1,625,000, which is higher than the EMV of selling. | |
| b. | She should sell as the EMV of selling is 906,250, which is higher than the EMV of developing herself. | |
| c. | She is indifferent between the two alternatives. | |
| d. | She should sell as the EMV of developing is less than the cost of $1,000,000. |
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