During the past few years, Wilder Company has experienced the following average number of power outages:
Each power outage results in out-of-pocket costs of US $800. For US $1,000 per month, Wilder can lease a generator to provide power during outages. If Wilder leases a generator in the coming year, the estimated savings (or additional expense) for the year will be
- US $(15,200)
- US $(1,267)
- US$3,200
- US$7,200
Answer(s): C
Explanation:
Each outage costs US $800, but this expense can be avoided by paying US $1,000 per month (US $12,000 for the year). The expected-value approach uses the probability distribution derived from past experience to determine the average expected outages per month.
3/12x0 = 0.0
2/12x1 = 0.16667
4/12x2 = 0.66667
3/12x3 = 0.75000
1.58334
The company can expect to have, on average. 1.58334 outages per month. At US $800 per outage, the expected cost is US $1,266.67. Thus, paying US $1.000 to avoid an expense of US $1,266.67 saves US $266.67 per month, or US $3,200 per year.