Suppose a different company offers Ludo Corporation a Loss Control service which costs S (in dollars)...

 

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Suppose a different company offers Ludo Corporation a "Loss Control" service which costs S (in dollars) and which cuts the probability of all losses in half (such that the probability of both the small loss and the large loss are reduced to 1/6 rather than 1/3), meaning that the new probability distribution for the Ludo Corporation's pre-tax income is given by 100 S 70-S with prob. 2/3 with prob. 1/6 20 S with prob. 1/6 For what values of S will Ludo Corporation prefer to buy the Loss Control service instead of doing what you concluded it would do in part (c) above, in order to maximize its expected after-tax income? (Assume for simplicity that it cannot buy both insurance and Loss Control, but must buy either only one of them or neither of them.) Suppose a different company offers Ludo Corporation a "Loss Control" service which costs S (in dollars) and which cuts the probability of all losses in half (such that the probability of both the small loss and the large loss are reduced to 1/6 rather than 1/3), meaning that the new probability distribution for the Ludo Corporation's pre-tax income is given by 100 S 70-S with prob. 2/3 with prob. 1/6 20 S with prob. 1/6 For what values of S will Ludo Corporation prefer to buy the Loss Control service instead of doing what you concluded it would do in part (c) above, in order to maximize its expected after-tax income? (Assume for simplicity that it cannot buy both insurance and Loss Control, but must buy either only one of them or neither of them.)

Answer rating: 100% (QA)

SOLUTION To determine the values of S for which Ludo Corporation will prefer to buy the Loss Control ... View the full answer