Alexander Industries is considering purchasing an insurance policy for its new office building in St. Louis, Missouri. The policy has an annual cost of $10,000. If Alexander Industries doesnt purchase the insurance and minor fire damage occurs, a cost of $100,000 is anticipated; the cost if major or total destruction occurs is $200,000. The costs, including the state-of-nature probabilities, are as follows:

Damage None Minor Major Decision Alternative 51 52 S3 Purchase insurance, d 1 10,000 10,000 10,000 200,000 Do not purchase insurance, d 2 0 100,000 Probabilities 0.93 0.06 0.01 (a) Using the expected value approach, what decision do you recommend? The best decision using the Expected Value approach is not to purchase insurance, with an expected cost of $ 8000 (b) Using the indiffence probabilities below, calculate the utility for $10,000 and $100,000. Let the utility of $0 be 10 and the utility of $200,000 be 0. (Note: Because the data are costs, the best payoff is $0.) Cost Indifference Probability 10,000 p = 0.99 100,000 p = 0.50 Cost Utility $0 10 $10,000 9900 $100,000 158 $200,000 0 (c) Using the utilities and indifference probabilities for the insurance defined in part (b). What decision would you recommend? purchase (d) Which method would you recommend to a risk adverse decision maker? Why? Use the expected utility approach. The other approach may result in a high -risk decision, where the decision maker is exposed to a $ loss. Damage None Minor Major Decision Alternative 51 52 S3 Purchase insurance, d 1 10,000 10,000 10,000 200,000 Do not purchase insurance, d 2 0 100,000 Probabilities 0.93 0.06 0.01 (a) Using the expected value approach, what decision do you recommend? The best decision using the Expected Value approach is not to purchase insurance, with an expected cost of $ 8000 (b) Using the indiffence probabilities below, calculate the utility for $10,000 and $100,000. Let the utility of $0 be 10 and the utility of $200,000 be 0. (Note: Because the data are costs, the best payoff is $0.) Cost Indifference Probability 10,000 p = 0.99 100,000 p = 0.50 Cost Utility $0 10 $10,000 9900 $100,000 158 $200,000 0 (c) Using the utilities and indifference probabilities for the insurance defined in part (b). What decision would you recommend? purchase (d) Which method would you recommend to a risk adverse decision maker? Why? Use the expected utility approach. The other approach may result in a high -risk decision, where the decision maker is exposed to a $ loss