a. When Sofia buys a computer for $1,000, she knows that there is a 10% chance that
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a. When Sofia buys a computer for $1,000, she knows that there is a 10% chance that it will break within the first year if she treats it with care. She is risk averse and would therefore pay up to $120 for a warranty that will replace the computer if it breaks for any reason during this period. If a risk-neutral firm offered her a warranty at this price, what would its expected profits be if it sold her a warranty at this price? Assume that she treats the computer with care.
b. Explain how moral hazard might undermine the firm’s calculations.
Related Book For
Management Accounting
ISBN: 978-0132570848
6th Canadian edition
Authors: Charles T. Horngren, Gary L. Sundem, William O. Stratton, Phillip Beaulieu
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