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2 August, 17:09

On January 1, Revis Consulting entered into a contract to complete a cost reduction program for Green Financial over a six-month period. Revis will receive $39,200 from Green at the end of each month. If total cost savings reach a specific target, Revis will receive an additional $19,600 from Green at the end of the contract, but if total cost savings fall short, Revis will refund $19,600 to Green. Revis estimates an 80% chance that cost savings will reach the target and calculates the contract price based on the expected value of future payments to be received.

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  1. 2 August, 20:46
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    The contract price based on the expected value of future payments to be received is $246,960

    Explanation:

    The computation of the expected value is shown below:

    For meeting the target, it will equal to

    = (Received amount * number of months + additional amount) * probability rate

    = ($39,200 * 6 months + $19,600) * 80%

    = $203,840

    For not meeting the target, it will equal to

    = (Received amount * number of months - additional amount) * remaining probability rate

    = ($39,200 * 6 months - $19,600) * 20%

    = $43,120

    So, the total expected value would be

    = $203,840 + $43,120

    = $246,960
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