The CRO of X$-$Wing Rentals is trying to find the optimal method of financing its space fighter physical damage risk. X$-$Wing is considering three risk financing techniques in order to address this loss exposure: a$)$ retention; b$)$ traditional third$-$party insurance; or c$)$ formation of a captive insurance company. Assume all three methods will meet intergalactic requirements. Also assume any financial information $($balance sheet numbers, loss expectations, etc...$)$ will remain stable for the next decade and that X$-$Wing$$s internal rate of return is $8\%.$

Decide which method of risk financing is most appropriate for dealing with losses over the next $10$ years. Use the balance sheet information, as well as the addition information below, to answer each of the following questions related to X$-$Wing and decide which method of risk financing is best for X$-$Wing.

X$-$Wing has decided to use the assets method to determine how much it is willing to retain. It has determined that it is willing to retain between $\mathrm{.}5\%-1\%$ of total assets $($see balance sheet at end of exam$)$ for its space fighter physical damage risk. X$-$Wing has reviewed its space fighter physical damage claims history and determined that its losses are roughly normally distributed with a mean of $$100,000$ and a standard deviation of $$50,000.$

X$-$Wing has also determined that start$-$up costs for the captive insurance company would be $$350,000$ and annual premiums will be a level $$125,000$ over the next $10$ years to ensure that the captive had the resources to pay all claims.

X$-$Wing also has received a quote from a highly rated third$-$party insurer who is willing to guarantee that X$-$Wing$$s insurance premiums will be $$160,000$ per year for the next $10$ years.

Question A:

If retention were not an option, would X$-$Wing be better off starting a captive or purchasing insurance from a third$-$party insurance company? Remember, this decision has a $10-$year time horizon. Justify your answer.

Question B$.$

What is the maximum amount, in dollars, that X$-$Wing would be willing to retain?

Question C$.$

Given X$-$Wing$$s loss distribution, and your answers to Questions A & B$,$ which risk financing method should X$-$Wing chose and why?

X$-$Wing Rental, INC BALANCE SHEET as of December $31$st$,2021$

ASSETS

Cash $$$$1,000,000\mathrm{.}00$

Accounts Receivable $$$$300,000\mathrm{.}00$

Notes Receivable $$$$200,000\mathrm{.}00$

Inventory $$$$1,500,000\mathrm{.}00$

Other Current Assets $$$$3,000,000\mathrm{.}00$

TOTAL Current Assets $$6,000,000$

Long Term Assets:

Buildings $$$$10,000,000\mathrm{.}00$

Less Depreciation $$$$(1,900,000\mathrm{.}00)$

Property and Equipment $$$$1,000,000\mathrm{.}00$

Less Depreciation $$$$(600,000\mathrm{.}00)$

Total Long Term Assets $$$$8,500,000\mathrm{.}00$

TOTAL ASSETS $$$$14,500,000\mathrm{.}00$

Long Term Liabilities

Mortgage $$$$5,500,000\mathrm{.}00$

Other $$$$1,000,000\mathrm{.}00$

Total Long Term Liabilities $$6,500,000\mathrm{.}00$

Stockholder's Equity:

Common Stock $$$$3,500,000\mathrm{.}00$

Retained Earnings $$$$500,000\mathrm{.}00$

Total Stockholder Equity $$4,000,000$

TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $$14,500,000$