Case Study: RCI and Southeastern Jianzhong Zhang

Situation RCI, a large company, takes calculated risks in projects that could produce energy. Negotiated a contract to build and operate a resource recovery facility for Westborough county. Construction will take a year from 1992 and cost $50 million. County will pay 5 equal installments of $10million when plant is 20, 40, 60, 80, and 100% complete. $10million will be held if plant didn’t work. Produce stem with an annual energy equivalent of 100,000 barrels of oil. Two possible customers: Acme Company, Southeastern electric company. Acme purchase steam from Nov. to April at a 20% discount form the price of Jan, 1st of each year, starting from Jan, 1st 1993 or 1994 Southeastern just buy steam for 1993, but need build a generating facility, which will take one year and cost $1 million Ignore the effects of taxes and time value of money

Decision for RCI Price range $30 to $50, current $35 per barrel, uncertainty Decide which steam will be sold to Negotiate with Southeastern to get max benefit Best: high price to sell to southeastern and no installments fee Give up Doesn’t’ work -$10millon 0.3 build Sell to Acme 100,000*0.5*oil price*80% 0.7 100,000*price -installments fee Southeastern

Decision for Southeastern Price from $30 to $50 Negotiate with RCI about price of steam and installment fee Give up Didn’t work - Fee to build the facility 0.6 build work Benefit from selling electric – 100,000* price – fee to build 0.4