Suppose that Neilson’s Restaurants has a liability exposure with expected loss payment equal to $3 million this year, $3 million next year, and $1 million in two years. Assume that Nielson’s can fully deduct all losses when calculating its taxable income, that it has a 34 percent tax rate, and that the interest rate equals 10 percent.
A) What is the present value of the expected tax shield arising from Neilson’s liability exposure if retention is chosen?
B) What is the present value of the expected tax shield arising from Neilson’s liability exposure if its lability exposure is insured through the Tennyson Insurance Company? That is, what would Tennyson’s expected tax shield equal?