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There is a 14% chance that the amount of oil in a prospective field is 5 million barrels and a 86% chance of 15 million barrels. If the actual amount of oil is 5 million barrels, the present value of the cash flows from drilling will be $1 million. If the amount is 15 million barrels, the present value will be $10 million. The cost to drill the well is $4.5 million. Suppose, a test that costs $250,000 can verify the amount of oil under the ground, is it worth paying for the test?
What is the net present value of not testing?
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