Reference no: EM131124826

Mountain States Electric Service is an electrical utility company serving several states in the Rocky Mountain Region. It is considering replacing some of its equipment at a generating substation and is attempting to decide whether it should replace an older, existing PCB transformer. (PCB is a toxic chemical known formally as Polychlorinated Biphenyl). Even though the PCB generator meets all current regulations, if an incident occurred, such as a fire, and PCB contamination caused harm either to neighboring businesses, farms or to the environment, the company would be liable for damages. Recent court cases have shown that simply meeting utility regulations does not relieve a utility of liability if an incident causes harm to others. Also, courts have been awarding large sums of money for damages to individuals and businesses harmed by hazardous incidents. If the company replaces the PCB transformer, no PCB incidents will occur and the only cost will be $85,000, the cost of the transformer. Alternatively, if the company decides to keep the existing transformer, then management estimates there is a 50% chance of a high likelihood for an incident and 50% chance of a low likelihood. For the high likelihood case, there is a .004 chance that a fire will occur sometime during the remaining life of the transformer and a .996 chance that no fire will occur. If a fire occurs, there is a .20 probability that it will be bad and the company will incur approximately $90 million for the clean ups. If the fire is a minor, the cost of cleaning up will be approximately $8 million. For the case where there is a low likelihood of an incident occurring, there is .001 chance that a fire will occur during the remaining life of the existing transformer and .999 chance that a fire will not occur. If a fire does occur, the same probabilities and clean up cost as the previous case will be true.

Perform a decision tree analysis for this problem and indicate the recommended decision using the expected value approach. Is this the decision that you believe the company should make? Explain your reasons.