Question

An oil-drilling company knows that it costs $25,000 to sink a test well. If oil is hit, the income for the drilling company will be $355,000. If only natural gas is hit, the income will be $130,000. If nothing is hit, there will be no income. If the probability of hitting oil is 1/40 and if the probability of hitting gas is 1/20, what is the expectation for the drilling company?

Answer 1

expectation = (1/40)(355000) + (1/20(130000)
= 15375

since it costs $25000 just to drill the well, this is not a good investment.