Question

Mel is thinking of going on a cruise. Mel values a cruise in nice weather at $2,000 and values a cruise in bad weather at $50. The probability of nice weather is 60% and the probability of bad weather is 40%. Trip insurance is sometimes available. If purchased, it allows travelers to delay the cruise until the weather is nice. If Mel is risk-neutral, then in the absence of trip insurance, the most she will be willing to pay for the cruise is _______. Select one: a. $1,200 b. $1,250 c. $1,220 d. $1,000

Answer 1

Mel

If Mel is risk-neutral, then in the absence of trip insurance, the most she will be willing to pay for the cruise is _______.

c. $1,220

Step-by-step explanation:

a) Data and Calculations:

Mel's value of a cruise in nice weather = $2,000

Mel's value of a cruise in bad weather = $50

Probability of nice weather = 60%

Probability of bad weather = 40%

Expected value:

Weather Outcome Probability Expected Value

Nice weather $2,000 60% $1,200

Bad weather $50 40% $20

Total expected value of a cruise $1,220