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The Value of Information 543

bad one. The course of action—drill if and only if the test is good—is also

shown on the tree.

How well off is the partnership with the perfect seismic test? In Figure 13.1,

we have computed the expected profit at the outset, before the test result is in.

Recall that the partners judge the probability of oil to be Pr(W)  .4. Since

good tests occur precisely when the site is wet, the frequency of a good test is

also .4. Similarly, Pr(B)  .6. Therefore, the initial expected value is

(.4)(600,000) (.6)(0) $240,000. Forty percent of the time, the seismic

result is good, and there is a $600,000 drilling profit. The rest of the time, the

result is bad, no drilling occurs, and the profit is zero.

How much is the test information worth to the partnership? The answer is

provided by the concept of the expected value of information. The expected

value of information (EVI)is simply the difference between the decision

maker’s expected value with the test information and without it. Thus, we can

write the expected value of information as

Recall from the discussion in Chapter 12 that, without the test, the best deci-

sion was to drill; the resulting expected profit was $120,000. In the present deci-

sion, the EVI is 240,000 120,000 $120,000.

The EVI measures the benefit of the test. So far we have not specified the

test’s cost. Suppose the test costs $50,000. Since the benefit exceeds the cost,

the partners should elect the test. Their expected net gain is EVI (Test cost) 

120,000 50,000 $70,000. If the cost were $150,000, however, the test would

not be worth its expense. The general rule is

 Expected value without information

EVIExpected value with information

FIGURE 13.1

A Perfect Seismic Test

A perfect seismic test

gives the wildcatter a

“sure thing.” He drills

“good” sites and

bypasses “bad” sites,

earning an expected

profit of $240,000.

–$200

$0

$600

Drill

Do not drill

Drill

Do not drill

Test reports “good”

Test reports “bad”

0

600

$0

.4

.6

240

Perfect test

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