Laura McCarthy, the owner of Riverside Bakery, has been approached by insurance underwriters trying to convince her to purchase flood insurance. According to local meteorologists, there is a 0.01 probability that the river will flood next year. Riverside's profits for the coming year depend on whether Laura buys the flood insurance and whether the river floods. The profits (which take into consideration the $10,000 premium for the flood insurance) for the four possible combinations of Laura's choice and river conditions are:
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The River
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Does Not Flood
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Floods
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Insurance Decision
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No Flood Insurance
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$200,000
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-$1,000,000
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get Flood Insurance
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$190,000
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$200,000
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a. If Laura decides not to purchase flood insurance, use the appropriate discrete probability distribution to determine Riverside's expected profit next year.
b. If Laura purchases the flood insurance, what will be Riverside's expected profit next year?
c. Given the results in parts (a) and (b), provide Laura with a recommendation.