Land purchase and 'limited site work' for power plant. Private utilities must obtain many federal, state, and local permits before constructing a coal-fired electric generating plant. In most cases, the key permit is from the federal agency responsible for writing the environmental impact statement [or the plant. Assume that a utility estimates the probability of the permit being denied as 0.2 and of being approved 0.8.
As part of the decision-making process, the utility must determine whether it is worthwhile purchasing land for the plant and if purchased, whether limited site work is to occur, ail before the permit decision is made by the federal agency. If the land is purchased, it is usually done anonymously through a real estate representative before any permits are applied for, in order to avoid possibly' having to buy at a premium from sellers who may be reluctant to sell their land for a power plant, and to avoid eminent domain proceedings that might be necessary later. If the land is purchased, a further decision must he made during the permitting process as to whether limited site work (clearing, grubbing road work, etc.) is to be carried out all at the utility’s risk. The incentive to begin site work is to advance any subsequent construction process thereby saving interest costs and avoiding inflated future construction costs. The danger in buying the land and doing site work is that if the permit is later denied the land would have to be sold usually at a loss to the utility.
For a particular case assume that the utility can immediately buy the necessary 100 acres of land for $1000 per acre, or that it could invest this money and have $1,20.000 accumulated at the time of the agency’s decision on the permit (the latter amount is thus the opportunity cost of the land purchase to the utility). If the land were purchased, the utility could also clear the site for an additional $100,000, again ex-pressed as the opportunity cost at the time of the agency’s permit decision. If the agency’s decision were to deny the permit, the utility could sell the cleared land for $1000 per acre (Zero appreciation in real terms), or the cleared land for $500 per acre. By clearing the land, the utility could advance its construction schedule and save $300,000 in interest and differential inflation costs if the permit were approved.
Alternatively, the utility could wait and purchase the land only if and when the agency approved the key permit. In this case the land would cost $1400 per acre. Also since the utility would have to negotiate directly with the landowners (or possibly go through eminent domain proceedings), the construction schedule would be delayed, causing a loss of $300,000 in interest and inflation costs. In any case, if the permit is denied, the utility would have to do something else to secure the necessary power, but it is assumed that there is no cost or benefit in so doing.
(a) Should the utility immediately buy the land or not and if purchased should 'limited site work' be carried out or not? Draw the complete decision tree and determine the optimal action and associated expected savings.
(b) Increase the probability of permit denial by tenths (to 0.3, 0.4, etc.) and determine the probability levels at which it would first become best not to clear the land and best not to buy the land immediately.
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