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Spreadsheet Assignment: Wacky O'Paddys Risk Management Decision (a fictional exercise) Stella Owl, the new owner of South Street's Wacky O'Paddys, LLC, noticed more and

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Spreadsheet Assignment: Wacky O'Paddys Risk Management Decision (a fictional exercise) Stella Owl, the new owner of South Street's Wacky O'Paddys, LLC, noticed more and more people taking pizza they purchased from her neighbor's small shop, Lamborghini's Pizza, into the outdoor seating at the Rambles at Head House Square just up the street from her bar. She has decided to purchase a pizza oven to attract more customers to her bar. While Wacky O'Paddy's does have an Irish pub bar vibe, she believes, as her ole ma, Mrs. Maloney, used to say, "that the best Irish Food is actually Italian." Stella Owl decided to purchase a pizza oven. As you can tell by the logo, Stella Owl is having other problems, too. All of her napkins and bling have the restaurant name spelled wrong as her contractor used ChatGPT to make it. She is involved in a small claims court dispute about this. However, as exciting as this might be, it is not part of the problem at hand, which is all about a pizza oven. The oven will cost $14,000 and is expected to generate a before-tax annual net cash flow of $12,500 in each of the nine years of its useful life, after which the oven will literally be "burned-out" -- that is, the oven will have no salvage value. This expected annual net cash flow does not include any allowance for possible damage to the oven. The oven will be used by Wacky O'Paddy's employees, who typically have limited experience and training due to the high turnover at these kinds of restaurants. Stella also requires an after-tax time-adjusted rate of return of 15 percent or greater (the rate of return that the store averages on its other assets). We can assume straight-line depreciation and an effective 30 percent income tax rate. As the owner of a small business, Ms. Owl is responsible for managing risks associated with it. Recently, she had to make a decision regarding the physical damage losses to the oven in her business. She had four options - either 1) retain the losses (retention), 2) retain the losses but spend $1,000 annually for safety training and maintenance on the oven (loss control), 3) Insure by spending $1,668 annually for a 0 $ deductible ACME Oven Insurance Policy or 4) $220 to insure damage to the oven with a deductible of 1000. With this policy there is still some loss not covered by ACME insurance and retained by Paddy O'Wacky's (as indicated in the insurance probability distribution given). It's a tough decision to make, but she will need to choose the option that works best for her business. Based on past loss experience, the annual expected amount of damage to the oven is described by the probability distributions below: Retention Probability Annual Losses Distribution Loss Control Probability Distribution Insurance Probability Distribution (no Deductible) Insurance Probability Distribution (with Deductible) $0 0.75 0.90 $4,500 $11,000 0.20 0.07 0.05 0.03 0.75 0.97 0.20 .02 0.05 .01 Note the insurance probability distribution with no deductible is the same as the retention because the insurance company faces the same risk as Ms. Owl does. Loss control changes the probability of a loss. As an example, Loss control has a 40% chance of having no loss, while the others have a 1% chance. The difference between the two insurance policies is that for the one with no deductible, Ms Owl is passing all risks to ACME Insurance Design a Microsoft Excel spreadsheet similar to the sheet in the "Loss Forecasts & Cash Flow Analysis" video lecture (Week 4) that calculates information needed to answer the following questions. Create a Microsoft Word document to answer the questions below. Please answer the questions in the order provided below and clearly label your answers 1, 2, or 3. Please do not retype the questions in the spreadsheet. Submit both the Excel spreadsheet and Word document under the assignment under Week 4 in our Canvas course site. QUESTIONS: 1. What is the annual expected value of the damage to the pizza oven if Stella does nothing to manage the risk? 2. Does the purchase of the oven and retention, loss control, or insurance generate an after-tax time-adjusted rate of return of 10 percent or greater? 3. Based on your quantitative analysis and other considerations in making the risk management decision, which risk management technique would you recommend that Stella decide to use? Why? Refer to your calculated information, as well as other considerations, and recommend only one technique for this assignment. If you have other considerations, what are the costs and benefits of them? Hint: the expected cost of having to pay the deductible is the probability of a loss > 1000 * 1000. This can be obtained from the last column in the table.

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