Question
Based on experience, you observe the following probabilities regarding the underlying cause of an observed cost or revenue variance: the probability, p , of a
Based on experience, you observe the following probabilities regarding the underlying cause of an observed cost or revenue variance: the probability, p, of a random variance equals 0.30, and the probability, 1 p of a nonrandom variance equals 0.70. If management chooses to investigate, the total cost is $2,000 if it is concluded that the reported variance is a random fluctuation, while the total cost is $4,000 if it is concluded that the variance is the result of a nonrandom (i.e., a systematic) cause (i.e., the incremental cost to correct the variance is $2,000). On the other hand, if an observed variance is not investigated, management expects the following costs: if it is concluded that the variance is due to random causes, the cost would be $0; if it is concluded that the observed variance is due to a nonrandom (i.e., a systematic) cause, the cost would be $44,000. Given this information, what is the expected cost (to the nearest whole dollar) of the decision to investigate the observed variance, E(investigate)? A) $0. B) $2,600. C) $4,100. D) $6,600. E) $7,100.
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