Trope Oil Company is considering drilling an exploratory well.The symbol P is the chance of a successful well,R is the revenue from a successful well,L is the price previously paid for the land,and C is the cost of drilling.The well will either be successful or dry.A company that is risk-neutral should drill if:
A) PR C.
B) PR C + L.
C) P(R - C) 0.
D) P(R - C - L) 0.
E) P(R - C) L.

Question

Trope Oil Company is considering drilling an exploratory well.The symbol P is the chance of a successful well,R is the revenue from a successful well,L is the price previously paid for the land,and C is the cost of drilling.The well will either be successful or dry.A company that is risk-neutral should drill if:
A) PR > C.
B) PR > C + L.
C) P(R - C) > 0.
D) P(R - C - L) > 0.
E) P(R - C) > L.

Quizplus · Accepted Answer

A risk-neutral company should drill if the expected value of the revenue from a successful well (PR) is greater than the cost of drilling (C). Therefore, A is the correct choice. Choice B includes the cost of land, which is not necessary for a risk-neutral decision. Choice C and D are not incorrect, but they are not the best choices because they include unnecessary variables. Choice E is incorrect because it is not necessary to consider the price paid for the land.

Trope Oil Company Is Considering Drilling an Exploratory Well