Jerry is interested in purchasing a washing machine. The price of ...

[bclement10]

Jerry is interested in purchasing a washing machine. The price of the machine is 500. The probability that the machine will break down is 20 every year.
 
  If the machine breaks down in the first year and Jerry holds a warranty, he receives a new washing machine worth 400 that year. If the machine breaks down after two years and he holds a warranty, he receives a new machine that is worth 300 after the second year. The price of a warranty for two years is 100. The market interest rate is 5. Is buying the warranty a good investment for Jerry? Explain your answer. Show all the necessary calculations.

Question 2

The economist George Stigler offered support for the Sherman Act when he said
 
  A) competition can only be preserved by protecting competitors from cutthroat competition.
  B) conglomerate mergers could not be prevented or regulated if it were not for the Sherman Act's prohibition of combinations in restraint of trade.
  C) predatory pricing costs businesses more than it saves consumers.
  D) the ghost of Senator Sherman is an ex officio member of the board of directors of every large company.
  E) the Sherman Act is essential if the Clayton act is to be enforceable in any way.

[aadams68]

Answer to Question 1

If the washing machine breaks down in the first year, Jerry will receive a new machine worth 400.
The present value of this machine is 400/1.05 = 381 approximately.
If the machine breaks down in the second year, Jerry gets a new machine worth 300.
The present value of such a machine is 300/(1.05 )2 = 272 approximately.
Hence the expected value of having the warranty is equal to
0.20  (381 ) + 0.20  (272 ) -100 = 76.20 + 54.4 -100 = 30.60.
In this case, since the expected value of an extended warranty is positive, it is a good investment for Jerry.

Answer to Question 2

D

[bclement10]

Thank you

[aadams68]

No problemo