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

Kelsey Castaneda

12 May, 01:31

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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George Lynn · 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