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 $500.

If they offer a 2 year extended warranty for $31, what is the company's expected value of each warranty sold?

Answer 1

The outcomes are $$31$ and -($$500$ -$$31$ )=-$$469$

The proabability of outcomes are $1-0.002=0.998 \text{ and }0.002$ respectively.

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

                  

             $=31\times 0.998+(-469)\times 0.002=30$

Hence Company's expected value is $$30.$