Scenario 17.3 Consider the Following Information

question 1

Multiple Choice

Scenario 17.3
Consider the following information:
The probability of a fire in a factory without a fire prevention program is 0.01. The probability of a fire in a factory with a fire protection program is 0.001. If a fire occurred, the value of the loss would be $300,000. A fire prevention program would cost $80 to run.
-Refer to Scenario 17.3. Moral hazard arises in this situation because once the firm:

• A) pays the premium that is based on the 0.001 probability, it has no incentive to spend the additional $80 for the fire protection program, so the true probability of loss is no longer 0.001.
• B) pays the premium that is based on the 0.01 probability, it has no incentive to spend the additional $80 for the fire protection program, so the true probability of loss is no longer 0.01.
• C) puts the fire protection program in place, it has less incentive to spend $300 for a premium, leaving the firm underinsured.
• D) puts the fire protection program in place, it has less incentive to spend $6,000 for a premium, leaving the firm underinsured.
• E) puts the fire protection program in place, it will consider that a substitute for insurance and not be able to deal with the loss from a fire should it occur.

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Definitions:

Net Income

The amount of profit left after all operating expenses, taxes, and interest are deducted from total revenue.

Indirect Method

In cash flow statement preparation, refers to starting with net income and adjusting for non-cash transactions to calculate operating cash flow.

Accounts Payable

Liabilities of a business that represent amounts owed to creditors for goods and services received but not yet paid for.

Accrued Liabilities

Liabilities recognized on the balance sheet before a company receives the related goods or services.