Four years ago, Victor Consuelo purchased a very reliable automobile (as rated b

Question

Four years ago, Victor Consuelo 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 $3,400. Consuelo constructs the following probability distribution with respect to anticipated costs if he chooses not to purchase the extended warranty.

Cost (in $) Probability 900         0.19          2,800         0.48          4,700         0.20          11,000         0.13          Calculate Victor’s expected cost.   Expected cost $    b. Given your answer in part (a), should Victor purchase the extended warranty? (Assume risk neutrality.) No Yes

Four years ago, Victor Consuelo 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 $3,400. Consuelo constructs the following probability distribution with respect to anticipated costs if he chooses not to purchase the extended warranty.

Explanation / Answer

Consider the table:

Thus, his expected cost is $3885. [ANSWER]

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b) As this is greater than the cost of waranty, then YES, HE SHOULD PURCHASE THE WARRANTY.

x P(x) x P(x) 900 0.19 171 2800 0.48 1344 4700 0.2 940 11000 0.13 1430

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