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David Byrne Co. owns a warehouse worth $250,000. Lou Reed is the risk manager. David Byrne faces the risk of fire which would completely destroy
David Byrne Co. owns a warehouse worth $250,000. Lou Reed is the risk manager. David Byrne faces the risk of fire which would completely destroy their warehouse. The probability of a fire is known to be 6%. David Byrne is considering the following risk management options to address the risk of fire to their warehouse: [1] Retention only - no Safety Program [2] Full Insurance Premium = $16,000 [3] Retention + Safety Program [4] Full Insurance + Safety Program Premium = $11,000 The cost of the Safety Program is $4,000. It has the impact of lowering the probability of a fire from 6% to 4%. However, if a fire does occur it is still a total loss. Assume that Reed's decision rule is to pick the option that minimizes total expected cost. Suppose Reed is offered a choice between full insurance without safety and retention without safety. What worry value for retention without safety (WVR) would make full insurance without safety preferred to retention without safety? Show all work and calculations and explain your numerical answer. [2 points] b. Suppose a Reed is offered a choice between full insurance with safety and retention with safety. What worry value for retention with safety (WVRS) would make full insurance with safety preferred to retention with safety? Show all work and calculations and explain your numerical answer. [2 points]
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