You are a member of the business development group for a firm that is a partner in a

consortium considering the submission of a proposal to build and operate a merchant

power plant in a developing country. The consortium is considering two designs; one

will utilize coal as a source of fuel while the other will use gas.

The major uncertainty is a pending environmental law that will significantly affect the

profitability of coal. You have made the following estimates for each alternative:

Technology Initial Investment $($$M$)$ Annual Net Cash Flow $($$M$)$

State $1$: new environmental law is enacted

Coal $10010$

Gas $20040$

State $2$: new environmental law is not enacted

Coal $10030$

Gas $20040$

a$.$ Calculate the NPV of each possible outcome if the discount rate is $15\%,$ the

concession period is $25$ years following construction completion and construction

is completed in period $0.$

b$.$ Your staff has estimated that the new environmental law has a $6050\%$ chance of

being enacted this year; if it is not enacted this year, you can assume that it will

not impact your plant. Draw the decision tree. If you base your recommendation

upon expected value, what is the preferred choice?