A company estimates that 0.9% of its products will fail after the original warranty period but within 2 years of the purchase, with a replacement cost of $200.

Question

If they offer a 2 year extended warranty for $22, what is the company's expected value of each warranty sold?

Answer 1

Each warranty results in $22 to the company.

Each failure cost them $200.

The failure rate is x = 0.9%

This means that the percentage of sold warranties that have no claim is 99.1%

So the expected revenue is:

22 * (0.991) - 200 * (0.009) = 20.002

Like most extended warranties, the company is winning and the customer is losing.