A company has a current tax rate of 30% and faces a 20% chance that the its output prices will drop and it will lose $100,000 over the next year.The firm would then be in a 15% tax bracket if it faces a loss.Compute the net present value (NPV)from purchasing insurance if the rate of interest is 5% and the beta of the output prices is 0.

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Quizplus · Accepted Answer

The correct answer is A because the NPV of the insurance is $2,857. The insurance premium is $1,000, and the expected loss is $20,000. The tax savings from the insurance are $3,000, and the present value of the tax savings is $2,857.

A Company Has a Current Tax Rate of 30% and Faces