Question

A company estimates that 0.7% of their products will fail after the original warranty period, but within two years of the purchase, with a replacement cost of $350. If they offer a two-year-extended warranty for $48, what is the company's expected value of each warranty sold

Answer 1

Answer:

The company's expected value of each warranty sold = $45.55

Explanation:

x = Resulting value for the company of replacing a failed product = Price two-year-extended warranty - Replacement cost = $48 - $350 = -$302

y = Resulting value for selling extended warranty to a product that does not fail = Price two-year-extended warranty = $48

Px = Probability of X occurring = 0.7%

Py = Probability of y occurring = 100% - Px = 100% - 0.7% = 99.30%

Therefore, we have:

The company's expected value of each warranty sold = (x * Px) + (y * Py) = ((-$302) * 0.7%) + ($48 * 99.30%) = $45.55