Question

Duke Energy has 14 coal sites throughout the state of North Carolina. Removing the coal ash from the sites has high costs today and provides possible future benefits. You are tasked with advising the governor of North Carolina on whether to require Duke Energy clean up all of its coal ash sites. The benefit of cleaning up the sites is the reduced risk of a potential spill and the costs associated with a spill.
All numbers are in real dollars (inflation corrected) and are expressed in present value terms (no need to discount- this has been done for you). Here are the facts:

Cost of cleaning up coal ash sites is $30 million today.
If the coal ash is not cleaned up

a. There is a 10% chance the coal ash ponds flood and causes $70 million dollars in damages.
b. There is a 20% chances the coal ash seeps into the ground water causing $100 million in damages.
c. There is a 70% chance the coal ash sites cause no damage to the state of North Carolina.

1. What is the expected benefit of cleaning up the coal ash site (i.e. how much do we expect to avoid in future damages)?
2. What sort of analysis would you undertake to advise the governor? Would you recommend the governor require Duke clean up the coal ash sites? (no need to complete calculation, just write the formula used for decision making)?

Answer 1

Answer:

1) expected benefits of cleaning up coal ash site is $27 million

2) The expected benefits of cleaning the site are less than the costs of cleaning them ($30 million cost > $27 million benefits). But the problem is that the cleaning costs will be covered by Duke Energy today, but in the future, there is a risk that the costs will be covered by the state government. Companies are not eternal and even industry leaders like Kodak, Sears, Toys R Us, Radio Shack, GM, etc., have gone bankrupt. The difference between the costs and the benefits is not that large to risk the state government having to pay for the cleaning costs in the future.

Explanation:

Costs of cleaning coal ash $30 million

Expected benefits form cleaning coal ash:

• $70 million x 10% = $7 million
• $100 million x 20% = $20 million
• $0 x 70% = $0
• total benefits = $27 million