Sample Exam Problems

Uncertain Technology - Meters

Many electric utilities are considering replacing the traditional electric meters with smart meters. However, the technology is very new and there are competing devices and standards. This question explores some of the tradeoffs utilities face. Suppose a smart meter using technology A can be installed for $600 in year 0, would last for 20 years, and would save $80 in labor costs every year (years 1-20) compared to a traditional meter. However, technology B is under development and will have more features. Meters using B will become available for installation in year 5, would operate in years 6-25, and would save $100 per year relative to a traditional meter. However, the purchase price of a type-B meter is uncertain: there is a 40% it would be $500 and a 60% chance it would be $900. Type-A meters will continue to be available in year 5 and would have the same cost and performance as in year 0.

Please determine what the utility should do and briefly explain your reasoning (be sure to be quantitative). What is the expected NPV of the optimal plan? If option value is involved, please calculate it. The utility uses an interest ra te of 10% in present value calculations.

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Peter J Wilcoxen, The Maxwell School, Syracuse University
Revised 05/01/2018