Carey Wildcatters has submitted a sealed bid for the rights to drill for oil in
ID: 1253697 • Letter: C
Question
Carey Wildcatters has submitted a sealed bid for the rights to drill for oil in a large tract of ocean off the coast of Florida. The bidder who submits the highest sealed bid will be awarded the rights to drill. The US Government has published geological information about the site. Based on this information, experts believe that the probability of striking oil is about 20%.
The winning bidder would also have to spend $10 million to make exploratory drill holes. If oil is found, the tract’s value will jump to $150 million. The owner could either develop the field or sell it to someone else. The drilling rights would become worthless if no oil is found, but the test rig equipment could be sold as scrap to salvagers for $1 million. Bids are permitted only in $1 million increments.
Wharton Associates is the only other serious bidder at this time. Carey has significant prior experience competing with Wharton. It has analyzed data on Wharton’s past bids on similar contracts and has assigned probabilities to the specific amounts that Wharton Associates may bid on the tract (see Columns 1 and 2 of the table on the next page). Carey management knows that the government has no reason to be biased in favor of either company. Thus, if the two bids are tied, the award would be decided by a coin toss (i.e., the award probability with tied bids would be 0.5 for each bidder).
(1)
(2)
(3)
Bid Amount
$ millions
Probability of
Wharton Bid
Probability of Stanford Bid
$7
0.10
0.00
$8
0.15
0.20
$9
0.15
0.20
$10
0.20
0.20
$11
0.15
0.20
$12
0.10
0.20
$13
0.10
0.00
$14
0.05
0.00
C. Carey now learns that a west coast company, Stanford Seismics, is also considering a bid on this tract. This company will bid independently as well, but within a narrower range of $8 million to $12 million. Carey has very little past information about how Stanford might bid and assigns equal probability to each bid within this range (see Column 3). With two competitors in the fray, Carey wonders if its biding strategy should change. What should Carey bid to maximize expected profit in this new situation? Show relevant calculations, the optimal bid amount, and the expected profit that Carey would make at this bid level
(1)
(2)
(3)
Bid Amount
$ millions
Probability of
Wharton Bid
Probability of Stanford Bid
$7
0.10
0.00
$8
0.15
0.20
$9
0.15
0.20
$10
0.20
0.20
$11
0.15
0.20
$12
0.10
0.20
$13
0.10
0.00
$14
0.05
0.00
Explanation / Answer
(1) (2) (3) Bid Amount $ millions Probability of Wharton Bid Probability of Stanford Bid $7 0.10 0.00 $8 0.15 0.20 $9 0.15 0.20 $10 0.20 0.20 $11 0.15 0.20 $12 0.10 0.20 $13 0.10 0.00 $14 0.05 0.00