Acme Inc. owns a small building worth $250,000. The firm can purchase full insurance for the risk of any physical damage to this building for a premium of $10,000. Assume that if a loss occurs, it will be a total loss. Assume the probability of a loss is 2%. The firm is also considering retention as an alternative to full insurance.
a. Construct an after tax loss matrix if the firms marginal tax rate is 30%.
b. Assume the risk manager wants to minimize expected losses (P*) as her decision rule. What risk management alternative does she choose? SHOW ALL CALCULATIONS.
c. Assume the risk manager has a worry value (wv) equal to $4,000 for retention. She's decided to minimize total cost. Using her decision rule, what risk management alternative does she choose? SHOW ALL CALCULATIONS.