Decision Analysis in Nuclear Power Plant Construction

Should the power company hire the geologist?

Should the nuclear power company hire the geologist for $1 million to analyze the fault structure at Diablo Canyon in order to make an informed decision on where to build the power plant?

Final Answer:

The decision to hire the geologist for the nuclear power company depends on calculating the Expected Value of Sample Information (EVSI) and the Expected Value of Perfect Information (EVPI) based on the probabilities of an earthquake and the cost of construction at the two sites.

Explanation:

To determine whether the nuclear power company should hire the geologist, we must calculate the Expected Value of Sample Information (EVSI) and the Expected Value of Perfect Information (EVPI).

Initially, the company has a 20% chance of losing $10 million at Diablo Canyon. Without hiring the geologist, the expected cost of building at Diablo is $12 million (20% of $10 million plus the construction cost of $10 million). The cost for building at Roy Rogers City is $20 million, so the company would choose Diablo as it is cheaper.

Let's examine the case where the geologist is hired for $1 million:

If the geologist predicts an earthquake (which happens 95% of the time when there is one), the company would decide not to build at Diablo. If the geologist predicts no earthquake (90% probability when there is no earthquake), the company would build at Diablo. Otherwise, the company will choose Roy Rogers.

EVSI helps in understanding the value of the geologist's information. The cost of failure is still $10 million at Diablo, but now we factor in the accuracy of the geologist's predictions and the $1 million cost for her services.

EVPI provides the value of having perfect information. It represents the most the company should be willing to pay for the information to make the best decision and is calculated as the difference between the EVwoI and the EV with perfect information.