Question

In this portion of the assignment, time value of money is considered.

1. A company expects to have annual cash flows of $50,000 for the next four years, and $100,000 in year five, after which it will cease to exist and have no residual value. Assume that all cash flows occur at the end of each year and the interest rate is 5%.

What is the total value of the company today (before consideration of risk)?

2. The company’s risk managers have found that there is a 20% probability each year that one lost time injury will occur. If a worker is injured, the company will incur $5,000 in medical expenses and $15,000 in lost time wages, payable at the end of the year. For simplicity, assume that each year’s probability is independent of the actual outcomes in the previous year(s) (probability remains constant for each year of the five year term) and the cost of injury remains constant from one year to the next (no inflation).   Furthermore, assume that the firm will face residual uncertainty costs of $3,000 each year.

What is the total value of the company now, recognizing this risk?

3. The risk managers have generated a loss control proposal, called Loss Control #1, that will cost the company $1,200 per year. This loss control proposal will reduce the probability of an injury to 12%, but will not reduce the costs of an injury should one occur. Residual uncertainty costs would be reduced to $1,600 per year.

What is the total value of the company now if Loss Control #1 is implemented?

4. The risk managers have identified a second more costly loss control proposal, called Loss Control #2. Loss control #2 will cost the company $2,500 per year but will reduce the probability of an injury to 8% and will reduce annual residual uncertainty costs to $1,200.

What is the total value of the company now if Loss Control #2 is implemented?

5. Instead of entertaining either of the loss control options, the risk managers have obtained a quote from Good Eye Insurance Company whereby all risks associated with an injury would be borne by Good Eye The annual premium for this policy is set at the expected value of loss plus a loading fee of 40%. Premium will be fixed for the five year period and will be payable at the end of the year. Under this option, assume that costs associated with residual uncertainty have been eliminated.

What is the total value of the company today if it purchases the insurance protection from Good Eye?

6. Finally, assume that Company B offers insurance protection under the same terms as Good Eye but that Company B requires the premium to be paid at the beginning of each year.

What is the total value of the company today if it purchases insurance protection from Company B?

7. Among the options outlined below, which risk management technique would you choose? (6 points)

• Do Nothing
• Loss Control #1
• Loss Control #2
• Good Eye Insurance Company Coverage
• Company B Insurance Protection

8. Why?

Answer 1

26/01/2020) ilisest Rate - 5% q Yrow Annual Cash flow 01 | $ 50000" $ 50000 $50000 $ 50000 5 $ 100000 I pur@5% Ammal CF *PUF 0.952 $47600 00907 $ 45350 0.864 $43200 0.822 841100 10.7834 L 878400 Total _ $2556 50 Votal Value of Company today 2 $255650, 12 Bocedea medical Expense 2 $ 5000 lost time wages - $ 15000 one lost timo injwy=2820000 brobability & 0.2 Annual Buobably one lost time in jiye2 $20000 402 aobable one last time injura 84000 чоң

tamb llaw 1-4 Ny.co. 47 $50000-$4000 $ 3000 kg 514klar $3$160000 $40000 --$93000 B5007 Tycar 1 23 4 og Testinual CF PUF @ Sy Annual CFA Pur 143000 10.952 & 40936 184-5000 0.907 d 3900 í $45000 8 864 $37152 $45000 0.822 § 3 5346 1993000 10 0784_1$ 72912 - Total $1,225347 Tohl Value of Company Teday is d. One lost time injury a $20000 » Revised beobalily 2 $12.74 Saving -88% $20000 8% Sasingin Annual Residual Risk =) $3000-1000 -- __$1400 Total Saving f.a $6000+ $1400 15000 300 A Baxaniq 4 $300u = $12.00 2 persen$1803 $1632.6 Annual A Saving. I pur@52 Annual CF HUIF SERLEO) $1800 00.952 $1713.6 Dogg 81800 10.901 febrero 1800 / 0.864 41555.2 oto 822 seed 18000784 1 Total & IN $1479.6 8141102 37792 2

implement Notal Value of Company y loss Control I is implen G 8 2 2 5367 + $ 1792.2 L.9'$.2331392m 22 ene lost femine enquiry 3 $20000 Revisid probabilitia 841 Baving ! 2 134.2 820000*240 ------ 282400 Saving in Annual Residual Risk -> $3000 - $1200 2 $1800 Voła Saving – $2400+ $1800 Ji a $4200___- Saving $4200 - $2500 a $100 per yeau Annual & Saving / PVF Annual D Savingpur $1700 10.1952 $1618.4 $1700 0.904 .254109 $1700 0.864 $146808 $17.00 T0.822 $1397.4 $1700. 10.784 1 & 1332.8 Jetal $7359.3 Total Value of Company is loss 2 $225f4f $ 232706-3 Control #2 is implements - $7359.3