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The Americo Oil Company is considering making a bid for a shale oil development contract to be awarded by the federal government. The company has decided to bid $110 million. The company estimates that it has a 60% chance of winning the contract with this bid. If the firm wins the contract, it can choose one of the three methods for getting the oil from the shale. It can develop a new method for oil extraction, use an existing (inefficient) process, or subcontract the processing to a number of smaller companies once the shale has been excavated. The results from these alternatives are given as follows.

Develop new process:
Outcomes Probability Profit ($ millions)
Great Success 0.30 600
Moderate Success 0.60 300
Failure 0.10 -100

Use present process:
Outcomes Probability Profit ($ millions)
Great Success 0.50 300
Moderate Success 0.30 200
Failure 0.20 -40

Subcontract:
Outcomes Probability Profit ($ millions)
Moderate Success 1.00 250

The cost of preparing the contract/bid proposal is $2 million. If the company does not make a bid, it will invest in an alternative venture with a guaranteed profit of $30 million. Construct a sequential decision tree for this decision situation and determine whether the company should make a bid.

Microeconomics, Economics

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