52. (Based on Balson et al. [1992].) An electric utilitycompany is trying to decide whether to replace its PCBtransformer in a generating station with a new and safertransformer. To evaluate this decision, the utility needsinformation about the likelihood of an incident, such as afire, the cost of such an incident, and the cost of replacingthe unit. Suppose that the total cost of replacement as apresent value is $150,000. If the transformer is replaced,there is virtually no chance of a fire. However, if thecurrent transformer is retained, the probability of a fireis assessed to be 0.005. If a fire occurs, the cleanupcost could be high ($100 million) or low ($30 million). The probability of a high cleanup cost, given that a fireoccurs, is assessed at 0.3.a. If the company uses EMV as its decision criterion,should it replace the transformer?b. Perform a sensitivity analysis on the key parametersof the problem that are difficult to assess, namely,the probability of a fire, the probability of a highcleanup cost, and the high and low cleanup costs.Does the optimal decision from part a remain optimal for a wide range of these parameters?c. Do you believe EMV is the correct criterion to usein this type of problem involving environmentalaccidents?
52. (Based on Balson et al. [1992].) An electric utility
company is trying to decide whether to replace its PCB
transformer in a generating station with a new and safer
transformer. To evaluate this decision, the utility needs
information about the likelihood of an incident, such as a
fire, the cost of such an incident, and the cost of replacing
the unit. Suppose that the total cost of replacement as a
present value is $150,000. If the transformer is replaced,
there is virtually no chance of a fire. However, if the
current transformer is retained, the probability of a fire
is assessed to be 0.005. If a fire occurs, the cleanup
cost could be high ($100 million) or low ($30 million). The probability of a high cleanup cost, given that a fire
occurs, is assessed at 0.3.
a. If the company uses EMV as its decision criterion,
should it replace the transformer?
b. Perform a sensitivity analysis on the key parameters
of the problem that are difficult to assess, namely,
the probability of a fire, the probability of a high
cleanup cost, and the high and low cleanup costs.
Does the optimal decision from part a remain optimal for a wide
c. Do you believe EMV is the correct criterion to use
in this type of problem involving environmental
accidents?
Trending now
This is a popular solution!
Step by step
Solved in 5 steps with 7 images
