Question

A company estimates that 0.8% of their products will fail after the original warranty period but within 2 years of the purchase, with a teplacement cost of $250.If they offer a 2 year extended warranty for $20, what is the company's expected value of each warranty sold?

Answer 1

Solution

- The outcomes are $250 and −($250 − $20) = −$230

- The probabilities of outcomes are 1 − 0.008 = 0.992 and 0.008 respectively.

- The company's expected value of each warranty sold is

$23(0.992)+(− 230)(0.008)=20.976\approx\ 20.98$

Final Answer

The answer is $20.98