Northern Electric
Postulate and justify the limits of uncertainty for an electric power-generating facility with the following six parameters:

Question

$5M	Building cost
$10M	Equipment cost
$2.5M	Annual net revenue
$1M	Salvage value
10%	i
20 years	N

Accepted Answer

Northern Electric’s experience is that major buildings cost between 80% and 150% of the estimates used to generate the request for proposals. The major equipment consists of naturalgas-fired turbines, which are “off-the-shelf ” items with actual costs between 90% and 110% of estimated costs. Growth in demand and associated revenues are difficult to predict, since this region has a boom/bust economy. Annual net revenues should be within 60% and 120% of the estimated quantity. The salvage value, S, has an estimated accuracy of 70% to 130%.

The appropriate interest rate for real economic returns over inflation should be between 6% and 15%. This is 60% to 150% of the base-case value. (This range has been made larger than it might be, so that nonlinearities would be more apparent.) The project horizon of N = 20 years should be between 15 years and 30 years, which is 75% to 150% of the base-case value. These uncertainties and the base-case values are summarized in Exhibit 17.4.

XHIBIT 17.4 Uncertainties in the data for Northern Electric

Upper Limit	Base Case	Lower Limit	Element
150%	$5M	80%	Building cost
110%	$10M	90%	Equipment cost
120%	$2.5M	60%.	Annual net revenue
130%	$1M	70%	Salvage value
150%	10%	60%	i
150%	20 years	75%	N

Question 17.3: Northern Electric Postulate and justify the limits of uncert...

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