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, a cost of such an incident and the cost of replacing a unit. Suppose 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 current transformer is retained, the probability of a fire is assessed to be 0.0025. If a fire occurs, then the clean-up cost could be high ($80 million) or low ($20 million). The probability of a high clean-up cost, given that a fire occurs, is assessed to be 0.2. If the company uses the expected monetary value as its decision criterion, should it replace the transformer? Perform 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 clean-up cost and the high and low clean-up costs. Does the optimal decision from part a) remain optimal for a “wide” range of these parameters?
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, a cost of such an incident and the cost of replacing a unit. Suppose 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 current transformer is retained, the probability of a fire is assessed to be 0.0025. If a fire occurs, then the clean-up cost could be high ($80 million) or low ($20 million). The probability of a high clean-up cost, given that a fire occurs, is assessed to be 0.2.
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- If the company uses the expected monetary value as its decision criterion, should it replace the transformer?
- Perform 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 clean-up cost and the high and low clean-up costs. Does the optimal decision from part a) remain optimal for a “wide”
range of these parameters?
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