The Central and Southeast Power Company of Mobile, Alabama, is considering a new power plant that will allow it to switch between gas and oil. The company has a contract to provide it with gas for $ 8 that is sufficient to produce one unit of electric power. (The numbers are standardized to one unit for ease of computation.) However, the plant can also be run using fuel oil. The price of fuel oil is uncertain, and the firm’s analysts believe that the uncertain future price can be characterized as a triangular distribution with a minimum value of $ 2, a most likely value of $ 7, and a maximum value of $ 12. Next year, the plant is expected to produce one standard unit of electrical power that can be sold for $ 10.
a. What expected cash flow from the power plant for next year if the cost of fuel is set equal to the minimum of the expected costs of gas and oil?
b. Construct a simple Crystal Ball simulation model for the plant’s cash flow using a triangular distribution for the cost of fuel oil and selecting the minimum-cost source of fuel to run the plant. What is the expected cash flow from the power plant based on your simulation?
c. If the cost of capital for the plant is 10% and the cash flows for the plant are expected to be constant forever, what is the value of the plant?