Group 3 - Lucia Horta, Kaylen Malley, Mitchell Young

IE 417

1-19-11

Problem 2 - Pg 772

A nuclear power company is deciding whether or not to build a nuclear power plant at Diablo
Canyon or at Roy Rogers City. The cost of building the power plant is $10 million at Diablo and $20
Million at Roy Rogers city. If the company builds at Diablo, however, and an earthquake occurs at Diablo
during the next five years, construction will be terminated and the company will lose $10 million (and
will still have to build a power plant at Roy Rogers City). A priori, the company believes there is a 20%
chance that an earthquake will occur at Diablo during the next five years. For $1 million, a geologist can
be hired to analyze the fault structure at Diablo Canyon. He will either predict that an earthquake will
occur or that an earthquake will not occur. The geologist's past record indicates that he will predict an
earthquake on 95% of the occasions for which an earthquake will occur and no earthquake on 90% of
the occasions for which an earthquake will not occur. Should the power company hire the geologist?

Build at Roy
Rogers $-20 M
9
$-30 M
Dont hire Earthquake
2 1
occurs
0.20 0

1 Build at 4 0.80 $-10 M

Diablo
Earthquake 1 $-31 M
1 Earthquake
doesnt occur 1
hire occurs
19/27 2
Says Earthquake Build at
3 occurs Diablo 7 8/27 $-11 M
0.27 5 Earthquake 1
Build at Roy doesnt occur 3
Says Earthquake 0.73 Rogers 1 $-21 M Earthquake $-31 M
doesnt occur 4 occurs 1
Build at Diablo
6 8 1/73 5
72/73
Earthquake $-11 M
1
Build at Roy Rogers doesnt occur
$-21 M 6
1
7
*Dollar values in millions
Explanation of given probability information:

From the problem, we are given the probabilities that an earthquake will occur and will not occur within
the next 5 years. We are also given the probability of the geologist predicting correctly given that there is
or isnt an earthquake. Given that there is an earthquake, 95% of the time the geologist predicts
correctly by determining that an earthquake will occur. Given that there is no earthquake, 90% of the
time the geologist predicts correctly by determining that no earthquake will occur. We also determined
the compliments of these probabilities. 5% of the time, the geologist will predict that there will be no
earthquake when there is actually an earthquake and 10% of the time the geologist will predict that
there will be an earthquake given that no earthquake actually occurs.
WinQSB:

Input:

Output:
Sensitivity Analysis: How much can we spend on the geologist?

Spend 1.05 million

Input:

Output:

Spend 1.08 million

Input:
Output:

Spend 1.09 million

Input:

Output:
Spend 1.095 million

Input:

Output:

Spend 1.096 million

Input:
Output:

Spend 1.1 million

Input:

Output:
SA Summary Table:

Amt to spend
Expected
on Geologist WinQSB Output Decision to make
Outcome
($ in millions)
Hire
Hire geologist, if predicts earthquake
If Predict earthquake BuildRR
1 -$13.9 build at Roy Rogers, if predicts no
If predict no earthquake Build
earthquake build at Diablo
Diablo
Hire
Hire geologist, if predicts earthquake
If Predict earthquake BuildRR
1.05 -$13.95 build at Roy Rogers, if predicts no
If predict no earthquake Build
earthquake build at Diablo
Diablo
Hire
Hire geologist, if predicts earthquake
If Predict earthquake BuildRR
1.08 -$13.98 build at Roy Rogers, if predicts no
If predict no earthquake Build
earthquake build at Diablo
Diablo
Hire
Hire geologist, if predicts earthquake
If Predict earthquake BuildRR
1.09 -$13.99 build at Roy Rogers, if predicts no
If predict no earthquake Build
earthquake build at Diablo
Diablo
Hire
Hire geologist, if predicts earthquake
If Predict earthquake BuildRR
1.095 -$14 build at Roy Rogers, if predicts no
If predict no earthquake Build
earthquake build at Diablo
Diablo
1.096 -$14 Dont hire BuildRR/D1 E/NE Dont hire geologist, build at Diablo

1.1 -$14 Dont hire BuildRR/D1 E/NE Dont hire geologist, build at Diablo

Turning point between 1.095 and 1.096 million (if geologist charges more than 1.095 million for
services, dont hire)

Utility Function:
Line Equation

y = mx + b

Finding Slope:

m = 1 / (difference of Smallest and Largest net return)

m = 1 / [ -10 - (-31)]

m = 1/21

Finding y-intercept:

Solve for b and use one given point.

b = y - mx

b = 0 - (1/21)(-31)

b = (31/21)

Line equation:

y = (1/21)x + (31/21)

U(-10 M) = 1

U(-31 M) = 0

U(-11 M) = .95

U(-20 M) = .5

U(-21 M) = .476

U(-30 M) = .0476

WinQSB Input with Utility Values

WinQSB Output with Utility Values
Decision Tree
Dear Manager,

After performing analysis on whether or not the company should decide to build the new
nuclear plant in Diablo Canyon or Roy Rogers City, and whether or not to hire a geologist to predict
future earthquakes at Diablo, we have found the following decisions to be most beneficial to the
company.

The company should hire the geologist to predict if an earthquake will hit Diablo in the next five
years. If the geologist predicts that an earthquake will occur, the company should decide to build the
plant at Roy Rogers. However, if the geologist predicts that no earthquake will occur, then the company
should build the plant at Diablo. Following this plan would cost the company an expected amount of
$13.9 million dollars. It is important to realize that this expected amount is not an exact value that the
company will be spending after one trial, but is instead the amount the company would expect to spend
after repeating this decision many times. However, making this decision of hiring the geologist will cost
the company either $31 million or $11 million if the hired geologist predicts that no earthquake will
occur and we build at Diablo, or it could cost the company a total of $21 million of the geologist predicts
an earthquake to occur, in which case the company would instead build at Roy Rogers City.

It is also important to know that if the geologist decides to raise his prices, we would still want to
use his predictions for up to an additional $95,000 and pay him a total of $1,095,000. However, if the
geologist decides to raise his prices to $1,096,000 or more, the company is better off to not use his
services and instead build at Diablo Canyon.