Question

A company estimates that 1% of their products will fall after the original warranty period but within 2 years of the
purchase, with a replacement cost of $480.
If they want to offer a 2 year extended warranty, what price should they charge so that they'll break even (in other words,
so the expected value will be 0)
(round to the nearest cent)​

Answer 1

Answer:

They should charge a price of $4.85 so that they'll break even.

Step-by-step explanation:

The expected value will be the sum of the net values multiplied by it's probabilities.

1% of their products will fall after the original warranty period but within 2 years of the purchase, with a replacement cost of $480.

So in 1% = 0.01 of the cases, the company loses $480. That is, a net value of -480.

In 99% = 0.99 of the cases, the company makes x.

The expected value is 0.

We have to find x.

So

$0.99x - 0.01*480 = 0$

$0.99x = 0.01*480$

$x = \frac{0.01*480}{0.99}$

$x = 4.85$

They should charge a price of $4.85 so that they'll break even.