An entity sells goods under warranty and past experience shows that minor defects account for 10% of sales and major defects account for 2% of sales. If all minor defects were repaired the warranty cost would be €300 000, and if all major defects were repaired the warranty cost would be €800 000. The expected value of the warranty cost is:

Question

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The expected value of the warranty cost is the sum of the products of the probability of each type of defect and the cost of repairing that type of defect. The probability of a minor defect is 10%, so the expected cost of repairing minor defects is €300,000 * 10% = €30,000. The probability of a major defect is 2%, so the expected cost of repairing major defects is €800,000 * 2% = €16,000. The total expected cost of the warranty is €30,000 + €16,000 = €46,000.

An Entity Sells Goods Under Warranty and Past Experience Shows