Question

Scenario 17-2 Imagine that two oil companies, Big Petro Inc. and Gargantuan Gas, own adjacent oil fields. Under the fields is a common pool of oil worth $24 million. Drilling a well to recover oil costs $1 million per well. If each company drills one well, each will get half of the oil and earn a $11 million profit ($12 million in revenue minus $1 million in costs). Assume that having X percent of the total wells means that a company will collect X percent of the total revenue. Refer to Scenario 17-2. If Big Petro Inc. were to drill a second well, what would its profit be if Gargantuan Gas did not drill a second well? $14 million $15 million $16 million $17 million

Answer 1

Answer: $14 million.

Let's first consider the division of the oil pool and keep the drilling costs aside. Since having X% of the wells implies an X% share of the total revenue, the total revenue has to be divided into 3 parts given that there will be a total of 3 wells. Since Big Petro Inc. earns 2 out of the 3 wells, its revenue collection would be proportionate that, i.e. (2/3)*24 million = 16 million.

Now since we know the cost of drilling each well is $1 million, its profit would be $16 million - $2 million (costs for digging 2 wells).

Therefore, profit= $2 million.