Sample Exam Problems

Uncertain Technology - Generation

Suppose an electric utility is considering building a new 500 MW power plant and is choosing between two types: C (conventional) and A (advanced). Type C is well understood: it would operate with a capacity factor of 0.9 and would earn $10 of per MWh after deducing fuel and maintenance costs. (That is, all costs other than the construction cost are accounted for and you don’t need to compute them.) Type A is advanced. It would use cheaper fuel and earn$20 of profit per MWh. However, its capacity factor is uncertain: there is a 50% chance it would be 0.9 and a 50% chance it would be 0.3 (down frequently for repairs). Both types cost \$1 million per MW of capacity and would last for 30 years. Either plant can be constructed immediately (period 0) and will produce power for 30 years (periods 1-30). The utility uses an interest rate of 5% in present value calculations.

1. Please determine the expected net present value of building each type of plant at year 0. Which type of plant would be best?
2. Now suppose that the underlying reliability of Type A plants will become known by year 5. That is, if the utility waits until year 5 to build, it could know the capacity factor of Type A plants for certain. Please determine whether that changes the firm’s decision and indicate the expected NPV of its best alternative.
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Peter J Wilcoxen, The Maxwell School, Syracuse University
Revised 05/01/2018