Assume all costs are normalized to real dollars; in other word, do not discount future cash flows.
You are the proposed program manager for the construction of a new electric power plant using solar thermal technology. This power plant is designed to last 10 years. Expenses to construct the plant are estimated to be $100 million but you have identified a 10 percent chance of litigation by environmental groups during this 10-year period over land use that could add $20 million to the cost of construction.
Over the plant's useful life, the electricity generated is expected to produce $40 million each year in revenue. However, you have several industry and Department of Energy reports indicating that increased demand for power and dwindling base load supply have a 25 percent chance of causing electricity prices to rise, so you could realize additional revenues of $10 million per year of operation. Partially offsetting that good news is a 40 percent chance that the county will raise real estate taxes for industrial land use that significantly affects natural habitats of certain wildlife species. This raise in taxes could potentially reduce your revenues by $2 million per year.
In addition, there is a 25 percent chance, per year of operation, of a fire caused by reflection from heliostats, which would reduce your revenue by 1 million in any year in which such a fire occurs. Insurance could be purchased to fully protect you from such losses for 250,000 per year. Other mishaps already are covered by a blanket insurance policy in the base operating costs.
Operational and maintenance costs to run the plant are expected to be $10 million a year.
Decommissioning costs at the end of the 10-year life would be $35 million (real current dollars). Your government affairs division estimates that there is a 35 percent chance that increased environmental requirements will be passed by the end of 10 years, so the decommissioning costs actually could be $5 million higher.
Answer the following questions:
1. What is the value of the project if none of the identified risk events occur?
2. What is the overall expected value of the project, considering the baseline and all risks?
3. What is the worst-case value for this project?
4. What is the best-case value for this project?
5. Would it be more prudent to purchase insurance against heliostat fires or risk the chance of a fire?