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Your firm faces a 6% chance of a potential loss of $45 million next year. If your firm implements new safety policies, it can reduce the chance of this loss to 3%, but the new safety policies have an upfront cost of $350 000. Suppose that the beta of the loss is 0 and the risk-free rate of interest is 5%.
-If your firm is fully insured, the NPV of implementing the new safety policies is closest to:

Question

Quizplus · Accepted Answer

The NPV of implementing the new safety policies can be calculated by comparing the expected loss without the policies to the expected loss with the policies, adjusted for the cost of implementing the policies. Without the policies, the expected loss is 6% of $45 million, which is $2.7 million. With the policies, the expected loss is 3% of $45 million, which is $1.35 million. The difference in expected loss is $2.7 million - $1.35 million = $1.35 million. After subtracting the cost of the policies ($350,000), the NPV is $1.35 million - $350,000 = $1 million. However, since none of the provided options match this calculation directly and considering the context of the question, it seems there might have been a misunderstanding in the calculation process. The correct approach should involve considering the risk-free rate for discounting if applicable, but given the beta of the loss is 0 (indicating no adjustment for risk is needed in discounting), and the straightforward calculation doesn't match any options, the closest correct choice based on the provided options and typical NPV calculation errors would be to recognize a mistake in the calculation explanation. The correct answer should reflect the net benefit or cost of implementing the safety measures, taking into account the reduction in expected loss and the upfront cost. Without the exact calculation leading to one of the provided choices, the selection is based on the logical error in the provided explanation.

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