) 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:

Question

) 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.

PsyDAG · Answer

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.