A company is offering a 2-year extended warranty on a refrigerator.

Question

A company is offering a 2-year extended warranty on a refrigerator. Their research indicates that, on average, about 1 out of 100 of these refrigerators will fail in the 2 years following the initial manufacturer's warranty. If the refrigerator does fail, they estimate that the repair/replacement cost will average $350.

1. If the store charges $15 for the extended warranty, what will their expected profit per warranty be?

? (Round to the nearest cent.)

2. If the company sells 500,000 refrigerators and 15% of the customers purchase the extended warranty, what will their expected profits from extended warranty sales be?

? (Round to the nearest dollar and do not use commas.)

Answer 1

1. The probability that one of the refrigerators will fail is .01, so the expected cost per refrigerator is .01 * $350 = $3.50.  If they charge $15 for the warranty, then the expected profit per warranty will be $15 - $3.50 = $11.50

 

2. 15% of 500,000 = 75000 warranties sold.  With an expected profit of $11.50 for each warranty, that will give them overall warranty profits of $862500.