CMA Final · Strategic Performance Management and Business Valuation · Risk Management
A project's cash loss, if a risk event occurs, is Rs 40 lakh. The probability of occurrence is 15%. Management buys cover that will pay 70% of any loss for a premium of Rs 3 lakh. What is the expected net cost of the risk to the firm, including the premium?
The expected net cost is Rs 4.80 lakh. Expected loss is 15% of Rs 40 lakh, which is Rs 6 lakh. The insurer bears 70%, leaving Rs 1.8 lakh retained, and adding the Rs 3 lakh premium gives Rs 4.8 lakh.
- ARs 4.80 lakhCorrect
- BRs 3.00 lakh
- CRs 6.00 lakh
- DRs 7.80 lakh
Explanation
Expected loss = 15% x 40 = Rs 6 lakh. Insurance bears 70%, so retained expected loss = 30% of 6 = Rs 1.8 lakh. Add premium Rs 3 lakh to get Rs 4.8 lakh. Rs 6 lakh ignores the cover, and Rs 7.8 lakh wrongly adds the premium to the unhedged loss.
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