1.)
Part A Small Warehouse worth $250,000 and tax rate of 15% Risk Management Options | Fire2% | No Fire98% | Full Insurance(Premium of $6,000) | $6,000(6,000) x (1- .15) = $5,100 | $6,000(6,000) x (1- .15) = $5,100 | Retention | $250,000(250,000) x (1- .15) = $212,500 | $0(0) x (1-.15) = $0 | Full Insurance + Loss Control(Premium of $4,000)(Loss Control cost $1,000) | $5,000(5,000) x (1- .15) = $4,250 | $5,000(5,000) x (1- .15) = $4,250 | Retention + Loss Control(Loss Control cost $1,000) | $251,000(251,000)x(1-.15) = $213,350 | $1,000(1,000) x (1- .15) = $850 |
Part B
Expected Losses:

Full Insurance = ($5,100) x (.02) + ($5,100) x (.98) = $5,100

Retention = ($212,500) x (.02) + ($0) x (.98) = $4,250

Full Insurance + Loss Control = ($4,250) x (.01) + ($4,250) x (.99) = $4,250

Retention + Loss Control = ($213,350) x (.01) + ($850) x (.99) = $2,975

The risk manager would choose the option of Retention and Loss Control because they desire the option with the lowest expected cost (P*).

Part C
Retention WV = $4,000
Retention with Loss Control WV = $3,000
TOTAL COST = P* + WORRY VALUE

Option 1 (Full Insurance): $5,100 + $0 = $5,100
Option 2 (Retention): $4,250 + $4,000 = $8,250
Option 3 (Full Insurance + Loss Control): $4,250 + $0 = $4,250
Option 4 (Retention + Loss Control): $2,975 + $3,000 = $5,975

The risk manager would choose the option of Full Insurance and Loss Control because it has the lowest total cost when compared to the other options. Total cost is P* plus the worry value, so full insurance is the best strategy to minimize the total cost.

2.) Part A Physical Plant is worth $1,000,000 Possible Loss in $ | $0 | $10,000 | $70,000 | $100,000 | $1,000,000 | Probability of Loss | 0.75 | 0.10 | 0.08 | 0.06 | 0.01 | Retention | $0 | $10,000 | $70,000 | $100,000 | $1,000,000 | Partial Insurance(Face Amount