Question

alexander industries is considering purchasing an insurance policy for its new office building in st. louis, missouri. the policy has an annual cost of $10,000. if alexander industries doesn’t purchase the insurance and minor fire damage occurs, a cost of $100,000 is anticipated; the cost if major or total destruction occurs is $200,000. the costs, including the state-of-nature probabilities, are as follows: damage none minor major decision alternative s 1 s 2 s 3 purchase insurance, d 1 10,000 10,000 10,000 do not purchase insurance, d 2 0 100,000 200,000 probabilities 0.94 0.05 0.01

Answer 1

The best expected decision is d2.

The equation for the expected value for the lottery will be 200000 - 20000P

How to calculate the decision?

The expected value for d1 will be:

= 10000(0.96) + 10000(0.03) + 10000(0.01)

= 10000

The expected value for d2 will be:

= 0(0.96) + 100000 (0.03) + 200000 (0.01)

= 5000

Therefore, the best expected decision is d2.

b. The best outcome is 0 and the worst is given as -200000. Therefore, the expected value for the lottery will be:

= P + 200000(1 - P)

= 200000 - 20000P

Therefore, the best expected decision is d2 and the equation for the expected value for the lottery will be 200000 - 20000P.

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Alexander Industries is considering purchasing an insurance policy for it's new office building in St. Louis, Mo. The policy has an annual cost of $10,000. If Alexander Industries doesn't purchase the insurance and minor fire damage occurs, a cost of $100,000 is anticipated: the cost if a major fire or total destruction occurs is $200,000. The cost, including state of nature possibilities are as follows:

Damage

decision alternative none s1 minor s2 major s3

purchase insurance d1 $10,000 10,000 10,000

Do not purchase insurance d2 0 100,000 200,000

probabilities .96 .03 .01

a. using the expected values approach, what decision do you reccommend?

b. What lottery would you use to access utilities?