Based on experience, you observe the following probabilities regarding the underlying cause of an observed cost or revenue variance: the probability, p, of a random variance equals 0.10, and the probability, 1 − p of a nonrandom variance equals 0.90. If management chooses to investigate, the total cost is $1,000 if it is concluded that the reported variance is a random fluctuation, while the total cost is $6,000 if it is concluded that the variance is the result of a nonrandom (i.e., a systematic) cause (i.e., the incremental cost to correct the variance is $5,000). On the other hand, if an observed variance is not investigated, management expects the following costs: if it is concluded that the variance is due to random causes, the cost would be $0; if it is concluded that the observed variance is due to a nonrandom (i.e., a systematic) cause, the cost would be $30,000.
Given this information, what is the expected cost (to the nearest whole dollar) of the decision to investigate the observed variance, E(investigate)?
A) $0.
B) $1,500.
C) $3,000.
D) $5,500.
E) $6,000.
Correct Answer:
Verified
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