Question

TerMite Hills (TH) owns the rights to land which may or may not have copper, a mineral used in semiconductors. There are three options for TH regarding exploration for copper on the land: partner, search for copper on their own, or sell the rights to the land. It is estimated that there is a 30% chance of finding copper on the land TH could establish a partnership with an experienced mining company. In this case TH would receive a payment of $50,000 from the partner company and would also share in the returns if copper is found. In the case where copper is found, TH is estimated to receive $200,000 for their share of the copper in the land. TH could explore for copper on their own. This alternative has a cost of $100,000 no matter what happens as TH must pay for the exploration. If copper is found, TH would receive the entire return estimated at $750,000. The third option for TH is to sell the rights to the land to another party for $120,000. Which of the following are true regarding the decision tree associated this problem? The initial or root node of the decision tree has 2 branches. The initial or root node of the decision tree is an event node. There are at least four event nodes in the decision tree. None of the answers are correct. There are three outcomes for at least one of the event nodes in the decision tree. TerMite Hills (TH) owns the rights to land which may or may not have copper, a mineral used in semiconductors. There are three options for TH regarding exploration for copper on the land: partner, search for copper on their own, or sell the rights to the land. It is estimated that there is a 30% chance of finding copper on the land TH could establish a partnership with an experienced mining company. In this case TH would receive a payment of $50,000 from the partner company and would also share in the returns if copper is found. In the case where copper is found, TH is estimated to receive $200,000 for their share of the copper in the land. TH could explore for copper on their own. This alternative has a cost of $100,000 no matter what happens as TH must pay for the exploration. If copper is found, TH would receive the entire return estimated at $750,000. The third option for TH is to sell the rights to the land to another party for $120,000. Which of the following are true regarding the decision that TH faces? If it is known that there is copper on the land, the best decision is for TH to "partner". None of the answers are correct. It is worth up to $279,000 to obtain information about the presence of copper on this land. The expected value with perfect information for this decision is $154,000. If it is known that there is no copper on the land, the best decision is for TH to "partner". TerMite Hills (TH) owns the rights to land which may or may not have copper, a mineral used in semiconductors. There are three options for TH regarding exploration for copper on the land: partner, search for copper on their own, or sell the rights to the land. It is estimated that there is a 30% chance of finding copper on the land TH could establish a partnership with an experienced mining company. In this case TH would receive a payment of $50,000 from the partner company and would also share in the returns if copper is found. In the case where copper is found, TH is estimated to receive $200,000 for their share of the copper in the land. TH could explore for copper on their own. This alternative has a cost of $100,000 no matter what happens as TH must pay for the exploration. If copper is found, TH would receive the entire return estimated at $750,000. The third option for TH is to sell the rights to the land to another party for $120,000. Which of the following are true, assuming that TH's own cost for copper exploration on the land increased from the current value of $100,000 to $125,000 ? The best decision for TH is to "partner" in this case. The EMV of the "explore on own" decision is $110,000. The EVPI is now $151,500. The EMV of the "partner" decision has increased. Exactly two answers are correct.

Answer 1

TerMite Hills faces three options regarding copper exploration: partnership, solitary exploration, or selling land rights. The best financial strategy varies depending on costs and the probability of finding copper, with decision trees helping to illustrate the outcome. The Expected Monetary Value assists in determining the best option given the costs and potential revenues.

Step-by-step explanation:

TerMite Hills (TH) is faced with three options regarding the exploration for copper, a critical mining material used in semiconductors: partner with another company, explore for copper on their own, or sell the rights to the land. Each option presents different financial outcomes based on the probability of finding copper, which is estimated at 30%. The decision-making can be broken down using a decision tree that illustrates the potential outcomes and their associated returns.

If copper is found, partnering could yield a $50,000 payment upfront plus a $200,000 share in returns, whereas exploring on their own costs $100,000 (or $125,000 if this cost increases), but with the chance to earn $750,000 if copper is discovered. Selling the rights guarantees a $120,000 revenue irrespective of the copper's presence. The best option depends on the actual costs of exploration and the estimated probability of finding copper.

The Expected Monetary Value (EMV) of each choice can be calculated, revealing the best financial strategy. The EMV of explore on own at the original cost would be 0.30 x $750,000 - $100,000 = $125,000. However, if the exploration costs increase to $125,000, the EMV drops to 0.30 x $750,000 - $125,000 = $100,000. The decision to partner would yield an EMV of 0.30 x $200,000 + $50,000, irrespective of the change in exploration costs. The Expected Value of Perfect Information (EVPI) measures how much paying for perfect information about the presence of copper is worth to TH. This would be the difference between the best decision knowing the results (exploring on their own if copper is present, or selling if not) and the best option without perfect information.

If TH knew there was copper, the best decision would logically be to explore on their own due to the higher returns compared to partnering. If no copper was present, selling the rights to the land would be the best decision to avoid exploration costs.