Question

​Genentech's main facility is located in South San Francisco. Suppose that Genentech would experience a direct loss of

$ 300 million in the event of a major earthquake disrupting its operations. The chance of such an earthquake is 2.5% per​ year, with a beta of −0.25.

a. If the​ risk-free interest rate is 5.5%​, and the expected return of the market is 11.5%​,

what is the actuarially fair insurance premium to cover​ Genentech's loss?b. Suppose the insurance company raises the premium by an additional 18%

over the amount calculated in part ​(a​) to cover its administrative and overhead costs. What amount of financial distress or issuance costs would Genentech have to suffer if it were not insured to justify purchasing the​ insurance?

a. If the​ risk-free interest rate is 5.5%​, and the expected return of the market is 11.5%​,

what is the actuarially fair insurance premium to cover​ Genentech's loss?The actuarially fair insurance premium to cover​ Genentech's loss is _________

million. ​ (Round to two decimal​ places.)

b. Suppose the insurance company raises the premium by an additional 18% over the amount calculated in part ​(a​) to cover its administrative and overhead costs. What amount of financial distress or issuance costs would Genentech have to suffer if it were not insured to justify purchasing the​ insurance? The amount of financial distress or issuance costs is

​___________million. ​ (Round to two decimal​ places.)

Answer 1

a.The required return for a beta of –0.25 is

rL= 5.5% – 0.25(11.5% –5.5%) = 4%

Premium=2.5%*300million/ 1.04=7.22 million

B.if premium raised to 18%

7.22+ 7.22×18%=8.5

now disruption cost is= 8.5=2.5%×amount/1.04=354 million answer