Question: A power plant that produces emissions of sulfur dioxide (SO2). Annual emissions are 1,000 tons per year in perpetuity and it currently faces an emissions tax of $20 per ton of SO2. The power plant can install a scrubber with a capital cost of $50,000. If it uses the scrubber, it incurs a one-time cost of $250,000 and the plant will not emit any SO2 for the remainder of its operational life. The plant faces a discount rate of 10%. There is no marginal cost to using the scrubber. We can thus view the scrubber as an option to control SO2 emissions in the future.

(A, 10 points): Should the power plant install the scrubber and commit to using it?

(B, 20 points): There is a 50% probability that the emissions price will increase to $35 per ton next year. Calculate the value of the option to control SO2 pollution. Should the power plant install the scrubber?