Question

Alexander Industries is considering purchasing an insurance policy for its new office building in St. Louis, Missouri. The policy has an annual cost of $10,000. If Alexander Industries doesn’t purchase the insurance and minor fire damage occurs, a cost of $100,000 is anticipated; the cost if major or total destruction occurs is $200,000. The costs, including the state-of-nature probabilities, are as follows: Damage Decision Alternative None minor major s1 s 2 s 3 Purchase Insurance, d 1 10,000 10,000 10,000 Do Not Purchase Insurance, d 2 0 100,000 200,000 Probabilities 0.96 0.03 0.01

Using the expected value approach, what decision do you recommend?

Assume that you found the following indifference probabilities for the lottery defined in part (b). What decision would you recommend?

Cost Indifference Probability 10,000 p = 0.99 100,000 p = 0.60

Do you favor using expected value or expected utility for this decision problem? Why?

Answer 1

Answer:

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