Question

Fed Ex has been experimenting with a new logistical service. With this new contract, there is a 30% chance that freight in shipping containers will be damaged by the contractor, resulting in a $10,000 loss of total value, on average. Otherwise, the full value of the cargo is realized, $100,000.

If Fed Ex is offered an insurance policy to protect them from loss at $4,000 per container, would should they buy the insurance?

None of these

yes, because the firm is risk averse yes, because they save $1000 of the expected loss

no, because the firm is better off gambling with the freight loss

no, because they can take the risk and be better off

Answer 1

Expected value of the cargo is = probability of damage x value of cargo + probability of not damage x value of caro

= 30%*90000 + 70%*100000

= 97000

In case the insurance covers for the loss, the net value of cargo will be 96000 after paying for insurance premium. This value is less than what is the expected value of the cargo if no insurance is taken, Hence it is not advisable to take insurance because insurance reduces the expected value of cargo

no, because the firm is better off gambling with the freight loss