Question

Name: 4. Bob Evans(BE) operates 2000 restaurants in the US Food contamination (e.g. E.com sa common risk in the food business. Whenever an outbreak of sickness due to eating food in a restaurant is reported, the restaurant has to take immediate actions, BE estimates that the probability of a reported outbreak in a restaurant on any given day is 0.00001. BE estimates that an outbreak in any one of its restaurants results in the following costs. Cleaning and sanitation of the entire restaurant $20.000 Disposing the entire food inventory $10,000. Re- inspection of incoming food stuff $5.000 Shutting down the restaurant for 2 days for cleanup. resulting in lost revenues of $100.000 on which the restaurant would have earned a pront of $33,000. Further, the restaurant has to issue free food coupons to attract back customers, whose usage results $5.000 in lost profits Estimate the expected total annual cost to BE from such outbreaks. BE restaurants operate 360 days in a year. An insurance company offers an insurance policy that would pay for the cleanup, food disposal, re-inspection and coupon costs (because these are verifiable costs), but insurance will not pay for the lost revenues/profits due to restaurant closure. The insurance premium is $ 100/ restaurant/year. Alternatively BE can overhaul its entire company value chain by instituting more rigorous testing program for food contaminants at every stage of the value chain. The estimated annual cost of staffing and operating such food safety testing program covering all its restaurants is estimated at $240,000. Implementation of the food safety testing program is expected reduce the probability of a reported outbreak in a restaurant on any given day to 0.000004 What should BE do? The choices are () do nothing. (i) buy insurance (ili) implement the food safety program. Please show all your intermediate steps and calculations clearly.

Answer 1

3 Cases are discussed as follows:
Case 1 : Do nothing
The same will result in total loss as follows.
(1 restaurant)
Cleaning and sanitation	$20000
Disposing inventory cost	$10000
Re inspection charges	$5000
Excess loss due to shutdown	$10000
Loss of revenue due to shutdown	$33000
Free food coupons	$5000
Total Loss	$83000
Case 2: Insure the business
Total Insurance cost(A)	$200000
Savings on Insurance
Cleaning and sanitation	$20000
Disposing inventory cost	$10000
Re inspection charges	$5000
Total savings(B)	$35000
Insurance cost - savings(A-B)	$165000
Add:Other loss
Excess loss due to shutdown	$10000
Loss of revenue due to shutdown	$33000
Free food coupons	$5000
Loss on Insurance cost	$213000
Case 3: If testing program implimented
Total cost	$240000
Total cost savings	$83000
Excess cost	$157000
Since the probability is very low(0.00001) and the cost to the company on insurance and testing program is very high, the same will results in excess cost to the company.
so the company dont want to do anything on the above case.