1. The Clark Company owns a warehouse worth $400,000. Ray Van-Eperen is the risk manager. The Clark Company faces the risk of fire which would result in a total loss to its warehouse. The probability of a fire occurring is known to be 2.5%.

The Clark Company is considering the following risk management options to address the risk of fire to its warehouse:

[1] Retention

[2] Retention + Safety Program

[3] Full Insurance, no safety program [Premium = $12,000]

The cost of the Safety Program is $5,000. It has the impact of lowering the probability of a fire from 2.5% to 1%. However, if a fire does occur, it is still a total loss ($400,000)

a) What is the Expected Cost for each option? If Rays decision rule is to minimize Expected Cost, which option will he choose? Show all work and calculations. [3 points]