Chapter 12, Problem 20P

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:

1. a. Using the expected value approach, what decision do you recommend?
2. b. What lottery would you use to assess utilities? (Note: Because the data are costs, the best payoff is $0.)
3. c. Assume that you found the following indifference probabilities for the lottery defined in part (b). What decision would you recommend?

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