Question

A company estimates that 0.1% of their products will fail after the original warranty period but within 2 years of the purchase, with a replacement cost of $500.

If they offer a 2 year extended warranty for $36, what is the company's expected value of each warranty sold?

Answer 1

$35.5

Explanation:

The outcomes are:

$36 [warranty cost]

and

-(500 - 36) = -$464 [replacement cost - warranty cost]

The probabilities are:

1 - 0.001 = 0.999 [ for the first ]

and

0.001 [for the second possibility]

Thus, the company's expected value for each warranty sold is:

36(0.999) + (-464)(0.001) = $35.5