Chapter 4,7,8,and term project

# Chapter 4,7,8,and term project - Math 3650 Practice...

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Math 3650 – Practice Problems - Chapters 4,7, 8 and term project 1. Define Internal Rate of Return (IRR). Define the Opportunity Cost of Capital. If the IRR equals the opportunity cost of capital, what is the Net Present Value of the project calculated using the opportunity cost of capital? 2. Briefly describe the Net Present Value decision rule. 3. What is the payback investment decision rule? Why is it not a very good rule for investment decisions? However, what useful information might it give management? 4. Compare the NPV decision rule to the IRR decision rule. When do they give the same answer as to whether or not to invest in a project? When could the IRR rule alone give the ‘wrong” answer? 5. Explain the role of “benchmark surplus” in insurance companies. Why is it used? How is benchmark surplus allocated to different products? Compare management asking you to increase the benchmark surplus allocated to a product to management asking you to increase the risk premium required on a product. 6. What are distributable earnings? 7. What is meant by the terms ‘expense allowable’ and ‘expense overrun’? 8. Storrs Life insurance Company has taxable income of \$8,000,000.  Given the  Corporate Tax rate table below, what is its marginal tax rate?

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Math 3650 – Practice Problems - Chapters 4,6,7 and term project 9. Give a brief description of the following, and explain how they are used: a. Break-even analysis b. Sensitivity analysis c. Scenario Analysis 10 What is the formula for calculating reserves? 11. What are the components of the distributable earnings for an insurance product (using our level premium term life example)?
Math 3650 – Practice Problems - Chapters 4,7, 8 and term project Answers 1. The IRR is the rate of interest where the present value of all of the cash flows of a project equals 0. The opportunity cost of capital is the best available rate offered by the market for an investment of comparable risk and term to the investment opportunity being considered. It is the rate at which the net present values should be calculated when using the net present value rule to evaluate an investment opportunity. Therefore, if the IRR equals the opportunity cost of capital, then the NPV will be zero. The IRR Rule only works if all of the project’s negative cash flows precede the positive cash flows. 2. The net present value of an investment opportunity is the present value of all of the cash flows discounted at the opportunity cost of capital. If the NPV is positive, then the PV of the benefits exceeds the PV of the costs at the opportunity cost of capital and the investment opportunity should be pursued. If the NPV is negative, the investment opportunity should be turned down.

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