In question #1 a., show how you calculated one ofthe after tax numbers in the ma

Question

In question #1 a., show how you calculated one ofthe after tax numbers in the matrix. Then you do not have to show the work for all of the after tax numbers in the matrix. Note that question #2 asks for before-tax values. You do NOT need to calculate after tax numbers for question #2. 1. A small company owns a $75,000 company car. If there is a loss, it is a total loss. The company's probability distribution for losses is estimated as follows: Loss (S Probability $75,000 is considering three options to manage this The risk manager risk: Retention Retention plus loss control Full insurance at an annual premium of S8,300 The loss control measure costs $3,500. Using the loss control measures is expected to result in the following loss distribution: Loss(S) 95 .05 $75,000 a. Construct an after-tax loss matrix. Assume that the firm's tax rate is 30%. (8 points) b. Suppose the risk manager's decision rule it to minimize after-tax expected loss. Which risk management alternative will she choose? (2 points) c. Assume that the risk manager has a worry value (Wv) equal to $2,000 for retention. Assume also that the WV for retention with loss control is $1,000 If the risk manager what risk management alternative does she choose? Show decides to (2 points)

Explanation / Answer

a.

b. To minimize expected after tax loss, decision of Retention plus loss control should be chosen

c. Incorporating worry values, the matrix now is

Best alternative still is retention plus loss control

Decision Expected Loss before tax Expected loss after tax Retention .1*75000+0 = 7500 7500*0.7 = 5250 Retention plus loss control .05*75000 + 3500 = 7250 7250*0.7 = 5075 Full insurance 8300 8300*0.7 = 5810

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