Willy's Only Source of Wealth Is His Chocolate Factory

question 5

Multiple Choice

Willy's only source of wealth is his chocolate factory.He has the utility function pc^1/2_f + (1 - p) c^1/2_nf, where p is the probability of a flood, 1 - p is the probability of no flood, and c_f and c_nf are his wealth contingent on a flood and on no flood, respectively.The probability of a flood is p = 1/14.The value of Willy's factory is $400,000 if there is no flood and 0 if there is a flood.Willy can buy insurance where if he buys $x worth of insurance, he must pay the insurance company $5x/18 whether there is a flood or not, but he gets back $x from the company if there is a flood.Willy should buy

• A)enough insurance so that if there is a flood, after he collects his insurance, his wealth will be the same whether there is a flood or not.
• B)enough insurance so that if there is a flood, after he collects his insurance, his wealth will be 1/6 of what it would be if there is no flood.
• C)no insurance since the cost per dollar of insurance exceeds the probability of a flood.
• D)enough insurance so that if there is a flood, after he collects his insurance, his wealth will be 1/25 of what it would be if there is no flood.
• E)enough insurance so that if there is a flood, after he collects his insurance, his wealth will be 1/11 of what it would be if there is no flood.

---

Definitions:

Total Asset Turnover

Total asset turnover is a financial ratio that measures a company's efficiency in using its assets to generate sales revenue.

Stockholders' Equity

The residual interest in the assets of an entity after deducting liabilities, representing the ownership interest of shareholders.

Inventory Turnover Ratio

A financial metric that shows how many times a company has sold and replaced its inventory over a certain period of time.

Average Sale Period

estimates the average time it takes for a company to sell its inventory.