Nielson Motors has a debt-equity ratio of 1 , an equity beta of 1 , and a debt beta of 0 . They are deciding if they wish to buy fire insurance against their factory burning down, which would result in loss of $103 Million with probability 5%. Because the risk of fire is idiosyncratic, the beta of the loss is zero. The risk-free rate is 5%, and the expected market return is 15%. If the loss is insured, or if Nielson is unaffected, their capital structure remains unchanged (debt-equity ratio of 1 , an equity beta of 1 , and a debt beta of 0 ). If uninsured, the firm will have no difficulty raising debt to rebuild the factory, but extra debt will change the capital structure: given that they have to rebuild the factory, Neilson will have debt-equity ratio of 1.5 , an equity beta of 1.9 , and a debt beta of 0.29. Next year, whether or now Neilson is affected by a loss, they will evaluate the following projects, none of which would change the Neilson's volatility (amounts in $ millions). a. What is the actuarially fair insurance premium? b. If the insurance company charges administrative expenses of 10% over the actuarially fair premium, what is the NPV of buying insurance? Data table (Click on the following icon in order to copy its contents into a spreadsheet.) Nielson Motors has a debt-equity ratio of 1 , an equity beta of 1 , and a debt beta of 0 . They are deciding if they wish to buy fire insurance against their factory burning down, which would result in loss of $103 Million with probability 5%. Because the risk of fire is idiosyncratic, the beta of the loss is zero. The risk-free rate is 5%, and the expected market return is 15%. If the loss is insured, or if Nielson is unaffected, their capital structure remains unchanged (debt-equity ratio of 1 , an equity beta of 1 , and a debt beta of 0 ). If uninsured, the firm will have no difficulty raising debt to rebuild the factory, but extra debt will change the capital structure: given that they have to rebuild the factory, Neilson will have debt-equity ratio of 1.5 , an equity beta of 1.9 , and a debt beta of 0.29. Next year, whether or now Neilson is affected by a loss, they will evaluate the following projects, none of which would change the Neilson's volatility (amounts in $ millions). a. What is the actuarially fair insurance premium? b. If the insurance company charges administrative expenses of 10% over the actuarially fair premium, what is the NPV of buying insurance? Data table (Click on the following icon in order to copy its contents into a spreadsheet.)
