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.

Question

Business

Diamond Jacobson

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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Alicia Kramer · Answer 1

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