Question

A company estimates that 0.2% of their products will fail after the original warranty period but within 2 years of the purchase, with a replacement cost of $150.


If they offer a 2 year extended warranty for $9, what is the company's expected value of each warranty sold?

Answer 1

Solution:

let x be the outcomes are $9 and -($150-9)=-$141

p(x) be the probabilities of outcomes are 1-0.002=0.998 and 0.002 respectively

Expected value =$\Sigma x*p(x)$

=(9*0.998)+(-141*0.002)

=8.982-0.282

=8.7

Answer:$8.7