A construction company is planning to build a new office building. The cost of construction is estimated
Question:
A construction company is planning to build a new office building. The cost of construction is estimated to be $10 million, and the construction period is expected to take two years. The company has identified a risk that the construction may be delayed due to bad weather conditions or unexpected problems with the supply of materials. The probability of a delay is 0.3, and the expected delay period is 6 months. If there is a delay, the company will incur additional costs of $1 million for each extra year of construction. The company is considering two options to manage this risk:
Option 1: Purchase an insurance policy that covers the additional costs if there is a delay.
Option 2: Create a contingency fund to cover the additional costs if there is a delay.
Assuming a risk-free interest rate of 5%, which option is more cost-effective for the company?
Business Statistics
ISBN: 9780321925831
3rd Edition
Authors: Norean Sharpe, Richard Veaux, Paul Velleman