Tutorial 3 S11

Tutorial 3 S11 - Tutorial 3 1.Alexander Industries is...

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Tutorial 3 1. 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 s 1 Minor s 2 Major 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 a. Using the expected value approach, what decision do you recommend? b. What lottery would you use to assess utilities? (Note: Because the data are costs, the best payoff is $0.) c. 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 d. Do you favor using expected value or expected utility for this decision problem? Why?
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Tutorial 3 S11 - Tutorial 3 1.Alexander Industries is...

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