Question

An aircraft company is considering using a new lightweight fastener, called the Superlight, to rivet certain sheet metal parts together. These particular items are not safety-of-flight critical, and so the decision of whether to use them is a financial one. The weight savings realized by using Superlights instead of the asic fastener has a net present value of $10 million (M) to the aircraft manufacturer. In this dollar range, assume that the company is a risk-neutral decision maker.
The Superlight fastener has never been used before on a production aircraft, and engineers are wary of its durability. From what little they know of the design and initial lab tests, they have high uncertainty about the number of Superlight fasteners that would need replacement during routine maintenance. They translate this to costs of S300 K with probability of 0.3, $120 K with probability 0.5, and $75 K with probability 0.2. (Label these possible cases High, Moderate, and Low repair cost, for future reference.) These costs include both parts and labor.

The alternative to the Superlight is the Basic fastener, which, although heavier than the Superlight, has been used extensively on past aircraft. Stress engineers feel that the Basic has a "tried and true" performance record: They conclude from past statistics that the repair cost associated with Basic fastener failure is $125 K. In these dollar ranges, assume that the aircraft company is a risk-neutral decision maker.

Required:
What is the certain equivalent for the best alternative?

Answer 1

Answer:

The best alternative is to use Basic Fastener.

Explanation:

The aircraft company has 2 alternatives. The first alternative is super light which has repair cost of $165k when the probability is considered. There are three possible situations where repair cost can be high, moderate or low. The repair cost calculation with probability is as follows:

300,000 * 0.3 + 120,000 * 0.5 + 75,000 * 0.2 = $165,000

The repair cost for Basic faster is $125,000.

It is suitable for the company to use basic fastener as it has proven records of performance and also its repair cost is lower than Super fastener.