Question

Walther owns a home in flood-prone Paradise Basin. If there is no flood the home and land together will be worth $2100. If there is a flood, Walther's home will be destroyed but the land will still be worth $800. There is 1/10 of chance that Walther's house will be destroyed by the flood. Walther can buy flood insurance for $0.2 per dollar of coverage. Let CF and CNF be the value of respective values of his land in the case of a flood or no flood. Suppose the equation CNF = a - CF/b represents the possible values of CNF and CF that Walther can achieve by buying some amount of insurance. What is the value a +b?

Answer 1

Answer:

a + b = 1,900 - 4 = 1,896

Explanation:

i = amount insured in $

CNF = $2,100 - $0.20i

CF = $800 - $0.20i + i = $800 + $0.80i

CNF = a - CF/b

$2,100 - $0.20i = a - ($800 + $0.80i)/b

$2,100 - $0.20i = a - $800/b - $0.80i/b

now we equate:

-0.2i = 0.8i/b

b = 0.8/-0.2 = -4

2,100 = a - 800/b

2,100 = a - 800/-4

2,100 = a + 200

a = 1,900

a + b = 1,900 - 4 = 1,896