(A) Construct a Decision Tree to Help the Power Company

question 89

Essay

(A) Construct a decision tree to help the power company decide what to do. Make sure to label all decision and chance nodes and include appropriate costs, payoffs and probabilities.
(B) Where should the power company build the plant? What is the expected cost?
(C) Suppose that a geologist (and his team) can be hired to analyze the fault structure at Chico Canyon. He will either predict whether an earthquake will occur or not. If the geologist is perfectly reliable, what is the most the company should be willing to pay for his services?
(D) Suppose that an actual (not perfectly reliable) geologist can be hired to analyze the earthquake risk. The geologist's past record indicates that he will predict an earthquake on 90% of the occasions for which an earthquake will occur and no earthquake on 85% of the occasions for which an earthquake will not occur. Given this information, what are the posterior probabilities that an earthquake will and will not occur, given the geologists predictions?
(E) Should the company hire the geologist if his fee is $1.5M?

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Definitions:

Public Corporations

Companies that have issued securities through an initial public offering (IPO) and are traded on at least one stock exchange or in over-the-counter markets.

Domestic Corporations

Companies that are registered and operate within the legal boundaries of a country, subject to its governance and taxation.

Nonstock Companies

Companies that do not issue stock as part of their ownership structure; often structured as cooperatives or mutual companies.

Par Preferred Stock

Preferred shares of a corporation with a nominal face value, which typically dictates dividends and liquidation claims.