Question

A company estimates that 0.7% of their products will fail after the original warranty period but within 2 years of the purchase, with a replacement cost of $300.
If they offer a 2 year extended warranty for $47, what is the company's expected value of each warranty sold?

Answer 1

Answer:

$44.90

Step-by-step explanation:

The resulting value for the company of replacing a failed product is given by the price of the warranty minus the cost of replacement:

$F= \ 47-\ 300 =-\ 253$

This event has a 0.7% chance of happening.

The resulting value for selling extended warranty to a product that does not fail is given by the proce of the warranty:

$W= \ 47$

This event has a 99.3% chance of happening.

The expected value is:

$EV = \ 47*0.993+(\ 47-\ 300)*0.007\\EV=\ 44.90$

The expected value for each warranty sold is $44.90.