The Americo Oil Company Is Considering Making A Bid F 482066

The Americo Oil Company Is Considering Making A Bid For A Shale Oil

The Americo Oil Company is evaluating whether to submit a bid for a federal shale oil development contract, which it plans to set at \$110 million. The company estimates a 60% probability of winning this contract with its bid. If successful, the company must choose among three extraction methods: developing a new process, using the current (less efficient) process, or subcontracting the extraction to smaller firms outside the company. Additionally, the company incurs a \$2 million cost to prepare the bid, and if it chooses not to bid, it will pursue an alternative venture with a guaranteed profit of \$30 million.

This decision-making scenario involves multiple stages and uncertainties, including the chance of winning the contract, the success probabilities of different extraction methods, and the associated profits. To systematically analyze these options, a sequential decision tree can be constructed to evaluate the expected outcomes of each choice, helping the company to determine whether bidding is a financially sound decision.

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Understanding sequential decision-making processes in investment and project management is crucial for companies facing complex choices under uncertainty. In this case, the Americo Oil Company's decision to bid or not, and which extraction method to choose if successful, embodies typical strategic planning issues faced in the energy sector.

Initially, the company's decision centers on whether to bid for the shale oil contract, costing \$2 million in proposal expenses. If the company decides not to bid, it secures a guaranteed profit of \$30 million from an alternative venture, eliminating any further risks or uncertainties related to the shale project. Conversely, bidding introduces the possibility of winning the contract, which occurs with a probability of 60%. This initial choice influences subsequent decisions and potential outcomes, forming the basis of the decision tree framework.

When considering whether to bid, the potential benefits must be weighed against the costs and risks involved. Should the company succeed in winning the contract, it faces a choice among three extraction methods, each with different success probabilities and profit outcomes:

• Development of a new process: 30% chance of great success yielding \$600 million, 50% chance of moderate success with \$300 million profit, and a remaining probability for failure (not specified explicitly but inferred as the complement to success probabilities).
• Using the current process: 50% chance of great success with \$300 million profit, and the remaining probability for moderate success or failure.
• Subcontracting: Probabilities and profits are specified but incomplete; thus, a typical analysis assumes that amateur or external subcontractors may yield variable profits depending on success rates, but detailed probabilities are necessary for precise calculations.

In realistic decision modeling, each of these options would be analyzed for their expected monetary value (EMV). For example, the expected profit from developing a new process equals the sum of the profits multiplied by their respective probabilities. Incorporating the chance of winning, the overall expected value of bidding must include the probability-weighted outcomes minus the bidding costs.

The decision tree method involves calculating the EMV starting from the end nodes associated with each outcome and moving backward (a process known as rollback analysis). The key calculations involve:

• Computing the expected profits for each extraction method based on their success probabilities and profits.
• Weighting these expectations by the probability of winning the contract (60%).
• Subtracting the bid preparation cost (\$2 million).
• Comparing the expected value of bidding vs. not bidding (which yields a guaranteed \$30 million).

By performing these calculations, the company can determine whether the expected benefits of bidding, considering the various extraction options, outweigh the guaranteed alternative profit and associated costs. If the expected value of bidding exceeds \$30 million, then participating in the bid is justified; otherwise, the company should opt for the guaranteed alternative investment.

In conclusion, constructing a detailed decision tree with accurate probability and profit estimates enables the Americo Oil Company to assess critically whether bidding for the shale oil contract aligns with its financial objectives. This approach exemplifies strategic decision analysis for resource-based industries operating under uncertainty, emphasizing the importance of integrating probability assessments, profit calculations, and cost considerations to make optimal investment choices.

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