Exercise 5-24 Algo Four years ago, Victor purchased a very reliable automobile (

Question

Exercise 5-24 Algo Four years ago, Victor purchased a very reliable automobile (as rated by a reputable consumer advocacy publication). His warranty has just expired, but the manufacturer has just offered him a 5-year, bumper-to- bumper warranty extension. The warranty costs $3,700. Victor constructs the following probability distribution with respect to anticipated costs if he chooses not to purchase the extended warranty. Cost (in ) Probability 1,000 2,300 4,600 9,500 0.26 0.40 0.20 0.14 a. Calculate Victor's expected cost. Expected cost b. Given your answer in part (a), should Victor purchase the extended warranty? (Assme risk neutrality.) Yes 0

Explanation / Answer

a) Victor's expected cost

= 1000(0.26) + 2300(0.40) + 4600(0.20) + 9500(0.14)

= $ 3430

b) Since the extended warranty cost is higher than expected cost, the answer is No.

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