Question

Yazoo Hills, Inc. is a boutique cardboard box manufacturing company and has paper stock inventory of $400,000. Yazoo has this entire inventory stored in one warehouse. There is a 2% chance that a fire could occur. If this fire occurs, then Yazoo will lose their entire inventory. [Option A]

As an alternative to keeping their entire inventory in one warehouse, Yazoo is considering separating their inventory evenly into two different warehouses. Once again, there is a 2% chance that a fire could occur in each warehouse. If this fire occurs, then Yazoo would once again lose their entire inventory in that particular warehouse. [Option B]

1. Construct the probability distribution for total losses under Option A. Once again remember that if a fire occurs, the loss will be $400,000. Hint: Think about the definition of a probability distribution and apply it in this case. (4 points)

2. Construct the probability distribution for total losses under Option B. Hint: In the case of Option B, you need to consider all the possible outcomes, recognizing that Yazoo now has two warehouses. Further hint…. Consider the rules of probability as discussed in class when you derive your probability distribution. Show probabilities to 4 decimal places. (6 points)

3. Compare the amount of risk Yazoo faces under Option A vs. Option B. Which option has more risk? Why? Show all of your work. And, explain your answer. (10 points) • Hint: Measurement of Risk = Coefficient of Variation = Standard Deviation / Mean Mean or EL = SUM of ($ amount of loss * Probability of that loss) each situation Variance = SUM of [(Prob of Loss * ($ amt of that loss – EL)^2] each situation SD = Square root of Variance

Answer 1