Reconsider the extended warranty decision in Example 15-8. Determine the cost of the extended warranty so that the expected costs of the actions to either purchase the warranty or not are equal.

Example 15-8

For deciding whether to purchase an extended warranty on a vehicle, we use the following model. The actions are
a₁ = purchase extended warranty

a₂ = do not purchase extended warranty

Assume that one of three states corresponding to a major, minor, or no repair can occur during the warranty period. We obtain probability estimates for each state. The states and associated probabilities are
s₁ = major repair, probability 0.1
s₂ = minor repair, probability 0.5
s₃ = no repair, probability 0.4

Finally, the costs C_km can be presented in a decision evaluation table in which each row is an action and each column is a state. We assume that the extended warranty coverage costs $200. Table 15-12 formally relates the cost of each action and possible future state.

Table 15.12

Transcribed Image Text:

0.4 Probabilities States Actions 0.5 0.1 S1 S3 S2 $200 $200 $200 $300 $1,200 $0 az