Question: Zipco is a firm that faces a 5 percent chance of suffering a $20 million lawsuit and a 95% chance of incurring no lawsuit in the next year. Zipco's taxable earnings are expected to equal $8 million in current year if it does not have to pay the lawsuit. Zipco's earnings will be taxed at a 34 percent tax rate if pretax earnings are positive. Zipco will incur no tax liability if its income is negative. Zipco can either buy liability insurance to cover the loss in full or retain the risk. (5 points, 1 point each)
Calculate the price of insurance, assuming the insurer charges the actuarially fair premium for the coverage.
Calculate Zipco's expected after-tax earnings if it buys insurance at the price shown in 5a.
Calculate Zipco's expected after-tax earnings if it does not buy insurance.
Redo 5b, but assume that Zipco's taxable earnings are expected to equal $30 million, not $8 million.
Redo 5c, but assume that Zipco's taxable earnings are expected to equal $30 million, not $8 million.