Question

You are considering buying insurance for your new laptop computer, which you have recently bought for $1,500. The insurance premium for three years is $80. Over the three-year period there is an 8% chance that your laptop computer will require work worth $400, a 3% chance that it will require work worth $800, and a 2% chance that it will completely break down with a scrap value of $100.Should you buy the insurance

Answer 1

Answer: Yes, because the expected cost of repair is greater than the cost of the insurance.

Explanation:

You should buy the laptop if the expected loss is greater than the insurance cost.

Expected loss = (8% * 400) + (3% * 800) + [2% * (1,500 - 100)]

= $84

The expected cost of $84 is greater than the insurance premium of $80 so you should buy the insurance.

Note; Expected cost if the laptop becomes scrap is ([2% * (1,500 - 100)] because the laptop will lose a value of $1,400 if it is scrapped.