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Posted by on Tuesday, July 21, 2009 at 2:47pm.

) 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 of Laura’s choice and river conditions are:
The River
Does Not
Flood Floods
Insurance No Flood
Decision 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 purchase the flood insurance, what will be Riverside’s expected profit next year?
c. Given the results in parts (a) and (b), provide Laura with a recommendation.

  • Statistics - , Wednesday, July 22, 2009 at 11:19am

    The four possibilities are:

    Buy, flood
    Buy, no flood
    Don't buy, flood
    Don't buy, no flood

    However, since there are no estimates of the profits from the previous year, more data is needed to estimate the profits under those conditions.

    I hope this helps. Thanks for asking.

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