Question

The owner of a small firm has just purchased a personal computer, which she expects will serve her for the next two years. The owner has been told that she "must" buy a surge suppressor to provide protection for her new hardware against possible surges or variations in the electrical current, which have the capacity to damage the computer. The amount of damage to the computer depends on the strength of the surge. It has been estimated that there is a 1% chance of incurring 550 dollar damage, 6% chance of incurring 150 dollar damage, and 15% chance of incurring 100 dollar damage from a surge within the next two years. An inexpensive suppressor, which would provide protection for only one surge, can be purchased. How much should the owner be willing to pay if she makes decisions on the basis of expected value?

Answer 1

Answer: The owner should not spend more than $29.95 for the surge.

Explanation:

Hi, to answer this question we have to multiply each probability by the cost incurred, and then add the results.

1% chance of incurring 550 dollar damage = (1/100) 550 = $5.5

6% chance of incurring 150 dollar damage = (6/100) 150 =$ 9

15% chance of incurring 100 dollar damage = (15/100) 100 = $15

Expected value of repairs: $5.5 +$9+$15 =$29.5

The owner should not spend more than $29.95 for the surge.

Answer 2

Answer: 26 dollars

Explanation:

The owner needs to consider that:

To measure the risk she can multiply the probability of an event to happen (P)* the impact (I) (in this case the impact is the cost).

All these eventes can be considered as independent between each other (no correlation), so you can add their P*I.

In this case:

P1*I1= 1%*550=5.5

P2*I2=6%*150=9

P3*I3=15%*100=15

So, the expected value of what she may spend for repairng is = P1*I1+P2*I2+P3*I3= 5.5+9+15= 29.5

She shoould not spend more than 29.5 dollars, otherwise, she will spend more in the surge supresor than in expected reapring value