Describe how the optimal decision change

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Assignment

Hydroelectric Dam Location

ASP&L is deciding whether to build a hydroelectric dam on the Travers River for $145 million in cost or on the French Canyon for $170 million. The Travers River site has seen a fair amount of minor seismic activity over recent years and the company believes there is a 15% chance over the next four years that the seismic activity could lead to a large enough earthquake as to render the site useless. In this case, they will be out the full $145 million and will need to rebuild at the French Canyon location.

Please express monetary amount in millions of dollars ($M) both in the model you construct and in responding to the questions posed.

Since this problem deals with cost instead of revenue or profit, click on the farther left label of your tree (the tree's name), to reveal the Tree Properties window. Click on the calculation tab and there change the Optimum Path to Minimum payoff (from Maximum payoff).

1. Assuming ASP&L uses Expected Value (risk-neutral) as their decision criterion, use Decision Tree to construct and solve a neatly labeled decision tree for their decision. What is the optimal decision for ASP&L?

2. ASP&L is interested in how sensitive the recommended strategy is to the probability of an earthquake occurring. Use Decision Tree to perform a sensitivity analysis on this value, varying it from 13% to 17%. Provide a sensitive plot showing the expected cost over this range for each location choice. Is there a "critical" value of this probability within this range at which the optimal decision changes? If so, provide the critical value, describe how the optimal decision changes, and explain intuitively why the change occurs.

3. ASP&L could hire a geologist with expertise in this area to predict whether such an event will occur in the next four years. What is the most ASP&L would be willing to pay for an expert prediction? Use Decision Tree to build a new tree that supports your answer. (Be sure to change the Optimum Path to Minimum payoff again in the Tree Properties!) Provide an explanation as to why they would not be willing to pay any more than the amount that you found in your analysis.

Reference no: EM133894689

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