Your company is conducting a risk assessment on the construction of an oil pipeline
project. If you build the pipeline, you will receive a total of between $200 million to
$400 million in royalties over the 20-year life of the pipeline. Unfortunately, there is a
risk of a rupture, and if the pipeline ruptures, your company will be liable for $800
million in damages. The probability of a rupture is low, however, at a level of
Prupture = 0.03. If there is a rupture, there is a 0.25 probability that political pressure
from the state in which the rupture occurs and unwelcome attention from the US
Congress and federal regulators will cause the total losses to the company to
quadruple to $3.2 billion.
Assume the income level from royalties is distributed uniformly. Use discrete
variables to represent the occurrence of a rupture and the likelihood of government
intervention.
What is the expected value (average outcome) of this pipeline project to your
company? Out of 10,000 trials, how often will your company experience a loss on
this project?

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