Question

Imagine that, with a discount rate of 5 percent, the net present value of a hydroelectric plant with a life of 70 years is $25.73 million and that the net present value of a thermal electric plant with a life of 35 years is $18.77 million. Rolling the thermal plant over twice to match the life of the hydroelectric plant thus has a net present value of ($18.77 million) + ($18.77 million)/(1 + 0.05)35 = $22.17 million. Now assume that at the end of the first 35 years, there will be an improved second 35-year plant. Specifically, there is a 25 percent chance that an advanced solar or nuclear alternative will be available that will increase the net benefits by a factor of three, a 60 percent chance that a major improvement in thermal technology will increase net benefits by 50 percent, and a 15 percent chance that more modest improvements in thermal technology will increase net benefits by 10 percent.

b. What is the quasi-option value of the thermal plant?

Answer 1