Grand East States (GES) is a railroad company operating in the Eastern United States. Juanita Salazar is risk manager at GES. At the direction of the companys chief executive officer, she is searching for ways to handle the companys risk in a more economical way. The CEO stressed that Juanita should consider not only pure risk but also financial risks. Juanita discovered that a significant financial risk facing the organization is a commodity price risk-their risk of a significant increase in the price of fuel for the companys locomotives. A review of the companys income and expense statement showed that last year about 28 percent of its expenses were related to fuel oil.

Juanita was also asked to determine whether the installation of a new sprinkler system at the corporate headquarters building would be justified. The cost of the project would be $40,000. She estimates the project would provide an after-tax net cash flow of $25,000 per year for three years, with the first of these cash flows coming one year after the investment in the project.

The company is considering expanding its routes to include Georgia and Florida. The CEO is concerned about the number of derailments that might occur. Juanita runs a regression with thousands of miles GES locomotives travelled as the independent variable and number of derailments as the dependent variable.

Results of the regression are as follows:

Y=2.31+.022X

With the expansion. GES trains will travel an estimated 640,000 miles next year.

With regards to the fuel price risk:

Discuss how Juanita could use futures contracts to hedge the price risk.

Discuss how a double-trigger, integrated risk management could be employed.

b. What is the net present value (NPV) of the sprinkler system project, assuming a rate of return required by GES investors is 10 percent?

c. How many derailments should Juanita expect next year, assuming the regression results are reliable and GES goes ahead with the expansion Plan