# Question: An electric utility company is trying to decide whether to

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 $75,000.

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 0.0025. If a fire occurs, the cleanup cost could be high ($80 million) or low ($20 million). The probability of a high cleanup cost, given that a fire occurs, is assessed at 0.2.

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 range of these parameters?

c. Do you believe EMV is the correct criterion to use in this type of problem involving environmental accidents?

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 0.0025. If a fire occurs, the cleanup cost could be high ($80 million) or low ($20 million). The probability of a high cleanup cost, given that a fire occurs, is assessed at 0.2.

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 range of these parameters?

c. Do you believe EMV is the correct criterion to use in this type of problem involving environmental accidents?

## Answer to relevant Questions

The ending of the game between the Indianapolis Colts and the New England Patriots (NFL teams) in Fall 2009 was quite controversial. With about two minutes left in the game, the Patriots were ahead 34 to 28 and had the ball ...Recall from Chapter 2 that the file Supermarket Transactions.xlsx contains over 14,000 transactions made by supermarket customers over a period of approximately two years. For this problem, consider this data set the ...The file P02_10.xlsx contains midterm and final exam scores for 96 students in a corporate finance course. For this problem, assume that these 96 students represent a sample of the 175 students taking the course, and that ...A manufacturing company’s quality control personnel have recorded the proportion of defective items for each of 500 monthly shipments of one of the computer components that the company produces. The data are in the file ...A drugstore manager needs to purchase adequate supplies of various brands of toothpaste to meet the ongoing demands of its customers. In particular, the company is interested in estimating the proportion of its customers who ...Post your question