Use the Information for the Question(s) Below

question 12

Multiple Choice

Use the information for the question(s) below.
Your firm faces an 8% chance of a potential loss of $50 million next year. If your firm implements new safety policies, it can reduce the chance of this loss to 3%, but the new safety policies have an upfront cost of $250,000. Suppose that the beta of the loss is 0 and the risk-free rate of interest is 5%.
-An operator of an oil well has a 0.5% chance of experiencing a catastrophic failure over the next year. This failure will cost the operator $500 million. If the risk-free rate is 2%, the expected return on the market is 8%, and the beta of the risk is -1.2, what is the actuarially fair insurance premium?

• A) $2,500,000
• B) $2,637,131
• C) $2,550,000
• D) $2,753,304

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Definitions:

Net Advantage

The benefit that results from a certain business decision, considering all related costs and revenues.

CCA Rate

Capital Cost Allowance rate, which is the percentage used to calculate depreciation for tax purposes on capital assets.

Salvage Value

The estimated resale value of an asset at the end of its useful life, considered in depreciation calculations.

After-Tax Cost of Debt

The net cost of debt to a company after accounting for tax deductions on interest payments, indicating the actual cost of borrowing.