A contractor must pay a $40,000 penalty if construction of an expensive home requires more than 16 weeks. He will receive a bonus of $10,000.00 if the home is completed within 8 weeks. Based on experience with the type of project, the contractor feels there is a 0.2 chance the home will require more than 16 weeks for completion, and there is a 0.0 chance it will be finished within 8 weeks. If the price of the home is $350,000 before any penalty or bonus adjustment, how much can the buyer expect to pay for her new home when it is completed?
Laura McCarthy , the owner of Riverside Bakery, has been approached by insurance underwriters trying to convince her to purchase flood insurance. According to local meteorologists, there is a 0.01 probability that the river will flood next year. Riverside's profits for the coming year depend on whether Laura buys the flood insurance and whether the river floods. The profits (which take into consideration the $10,000 premium for the flood insurance) for the four possible combinations for Laura's choice and river conditions are
Does NOT Flood Floods
Insurance Decision No flood insurance $200,000 -$1,000.000
Get flood insurance $190,000 $200,000
a. if Laura decides not to purchase flood insurance, use the appropriate discrete probability distribution to determine Riverside's expected profit next year.
b. If Laura purchases the flood insurance, what will be Riverside's expected profit next year?
c. Given the results in part (a) and (b) provide Laura with a recommendation.
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