DYNAMIC STRATEGIC PLANNING

MID-SEMESTER QUIZ October, 1997

NOTE CAREFULLY!

The questions on the quiz test different capabilities. Furthermore, each question generally proceeds from easier to more difficult concepts. Examinees should therefore allocate their time optimally, by responding first to the questions that are easiest, and setting aside until the end the questions which are more difficult for them.

For your guidance, the points associated with each question are marked in parentheses alongside the question. They are calibrated with the time it should take to answer the question -- one point possible per minute.

The total number of points possible = 90

 

Name: _________________________________________

 

 

Question

Section

Maximum points

Actual points

1

A

3

 

B

3

 

C

3

 

2

A

6

 

B

6

 

C

6

 

D

6

 

E

4

 

F

3

 

3 (1)

A

3

 

B

6

 

3 (2)

A

3

 

B

3

 

C

5

 

D

4

 

E

3

 

F

10

 

G

5

 

H

4

 

I

4

 

 

 

QUESTION 1

Answer the following questions:

  1. Define discount rate (3)
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  3. What criteria or reasoning should you use to calculate the discount rate? (3)
  4.  

     

     

     

     

  5. How does discount rate relate to interest paid on loans to finance a project? (3)

QUESTION 2

Take the production function for the generation of electricity as a function of the amount of fuel (F), the cost of labor (L) and the size of the facility (S):

Q = F.4 L.3 S.2

Additionally, assume that the input cost function is:

C = F + 0.5 L1.5 + 0.25 S 2

  1. For a given point of operation (F=2, L=3, S=4), by how much should you change the input of labor if the input of fuel decreases by one unit and you want to keep the production constant? (6)
  2.  

     

     

     

     

     

     

     

     

  3. State the conditions for optimal design as they apply to this case. (6)
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  5. Define in words the expansion path. Find the equation of the expansion path for the generation of electricity, stating the values of L and S in terms of F. (6)

 

 

 

 

 

 

 

  1. Find the cost function for the generation of electricity. (6)
  2.  

     

     

     

     

     

     

     

     

  3. Define in words Returns To Scale (RTS). What can you say about the returns to scale of the production of electricity? (4)
  4.  

     

     

     

     

     

     

     

     

     

     

     

  5. Does this production process exhibit economies of scale? (3)

 

QUESTION 3

Your company is planning to build a new power plant of 500 MW. You are analyzing two alternatives fuel sources: coal or gas.

The payoffs for your investment are uncertain because new environmental law may be enacted which will affect the profitability of coal. Table 1 summarizes the return from your investments for the possible scenarios.

Technology

Initial investment (in $M)

Yearly net cash flow (in $M)

Scenario 1: new environmental law is enacted

Coal

100

10

Gas

200

40

Scenario 2: new environmental law is not enacted

Coal

100

30

Gas

200

40

Your discount rate is 15%.

I Economic evaluation

  1. Assume that you have to spend your investment immediately, but that your revenues start at the end of the first period. Draw the cash flow diagram for the gas-powered plant in Figure 1. (3)

  2. Assume that the revenues last at least 25 years, estimate the approximate value of each of the possible outcomes. (6)

 

 

 

 

 

 

II Decision analysis

Your staff in the marketing department estimates that new environmental regulation has a 60% chance of being enacted this year. If the legislation is not enacted at this time, you can assume it will not apply to your power plant.

  1. Draw the decision tree. (3)
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  3. Basing your recommendation on expected value, what is the preferred choice? (3)
  4.  

     

     

     

     

  5. What is the EVPI concerning the passage of this legislation? (5)
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    It seems that you could pay a consulting firm specialized in government affairs to get information on whether the new legislation will be enacted. From the evidence of their previous performance, you estimate that the firm is right in its predictions 80% of the time.

  7. Draw the decision tree showing this new possibility (4)
  8.  

     

     

     

     

     

     

     

     

     

  9. Show all payoffs. (3)
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  11. Show all probabilities. (10)
  12.  

     

     

     

     

     

     

     

     

     

  13. Is the sample information worth 5 million $? Show calculations. (5)
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  15. Perfect information about whether the legislation is passed this year could be obtained simply by deferring the project - and its benefits - by a year. What is the true cost of this strategy, in terms of deferred benefits? (4)
  16.  

     

     

     

     

     

  17. How much would you be willing to pay the Government for the right to defer the project by a year? (4)