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Homework answers / question archive / MotoWin Auto Superstore is thinking about offering a two-year limited warranty for $928 on all new cars of a certain model
MotoWin Auto Superstore is thinking about offering a two-year limited warranty for $928 on all new cars of a certain model. The terms of the warranty would be that MotoWin would replace the car free of charge under certain, specified conditions. Replacing the car in this way would cost MotoWin $13,800 . Suppose that under the warranty, there is a 7% chance that MotoWin would have to replace the car one time and a 93% chance they wouldn't have to replace the car.
Would this be 13800 x 0.07 + 928 x 0.93 ???
Answer:
They are expected to lose $38 out of every warranty purchased.
Step-by-step explanation
The expected profit they would make using this warranty scheme is:
E(x)=(928-13800)*0.07+928*0.93
E(x)=$-38.00
Therefore, they are expected to make a loss of $38 for every limited warranty purchased by a customer.
You almost got this correct, however, in the case where they have to replace the car they lose $13800 (therefore it is negative) but they also have gained the $928 that the customers paid for the warranty, therefore making the loss $12872 7% of the time.
