Based on Experience, You Observe the Following Probabilities Regarding the Underlying

question 132

Essay

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.

• A) $0.
• B) $1,500.
• C) $3,000.
• D) $5,500.
• E) $6,000.

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Definitions:

Polluting Firms

Companies that release harmful substances into the environment as a byproduct of their production processes.

Emissions Standards

Emissions standards are government-imposed limits on the amount of pollutants that can be emitted by vehicles and other sources, to protect environmental and public health.

Marginal Social Benefit

The supplementary advantage to society from the production or utilization of an additional unit of a product or service.

Pollution

The introduction of harmful substances or products into the environment, causing adverse effects on living beings and ecosystems.