CMA Final · Strategic Performance Management and Business Valuation · Risk Management
Bharat Auto Components Ltd estimates that a supplier disruption could occur with a probability of 0.20 and would cost Rs 15,00,000 if it happens. Management can buy a standby-supplier arrangement for Rs 2,00,000 a year that would cut the probability to 0.05 with the loss unchanged. What is the net benefit (reduction in expected loss less cost) of the arrangement?
The net benefit is Rs 25,000. Expected loss falls from Rs 3,00,000 (0.20 x 15,00,000) to Rs 75,000 (0.05 x 15,00,000), a reduction of Rs 2,25,000. Deducting the annual arrangement cost of Rs 2,00,000 leaves Rs 25,000, so the arrangement is marginally worthwhile.
- ARs 25,000Correct
- BRs 75,000
- CRs 3,00,000
- DRs 2,25,000
Explanation
Expected loss before = 0.20 x 15,00,000 = Rs 3,00,000. After = 0.05 x 15,00,000 = Rs 75,000. Reduction = Rs 2,25,000. Net benefit = 2,25,000 - 2,00,000 = Rs 25,000. Rs 2,25,000 ignores the cost of the arrangement, and Rs 75,000 is just the residual expected loss.
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