The owner of a small firm has just purchased a personal computer, which she expe

Question

The owner of a small firm has just purchased a personal computer, which she expects will serve her for the next two years. The owner has been told that she "must" buy a surge suppressor to provide protection for her new hardware against possible surges or variations in the electrical current, which have the capacity to damage the computer. The amount of damage to the computer depends on the strength of the surge. It has been estimated that there is a 2% chance of incurring 500 dollars damage, 5% chance of incurring 300 dollars damage, and 13% chance of 75 dollars damage. An inexpensive suppressor, which would provide protection for only one surge, can be purchased. How much should the owner be willing to pay if she makes decisions on the basis of expected value?

Explanation / Answer

In order to give an answer, I would have to assume a few more details. Like, how does she amortize the costs, what is her internal cost of money, etc. A much *simplified* calculation is like this: 2% x 300 = $6 5% x 250 = $12.50 13% x 150 = $19.50 Add them up, I get $38. But the values seem much too small to me. A surge will cost a lot more than $300, when you consider the lost business and value of the owners time.

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