Chapter 2 Discussion Questions
1.
What is the objective of risk management, and is it consistent with maximization of firm value?
1.
Minimize the cost of the risk
1.
cost of paying expected loss
2.
cost of residual uncertainty: how much uncertainty after methods have been
implemented
3.
cost of risk management methods
2.
value of firm (w/risk) = value of firm (w/o risk) – cost of risk
Cost of risk: exp loss, cost of rm, cost of r.u.
2.
The value of a firm in an ideal world of no risk is $100,000. But, in the real world, the firm
faces the risk of an injury to one of its workers, where the probability of injury is 10 percent and
the resulting losses would be $60,000.
The firm is considering four options for dealing with
risk:
Option 1: Do nothing & pay expected losses out of the firm's own resources. The cost of
residual uncertainty is $4,000.
Option 2: Invest $2,000 in loss control that would reduce the chance of loss to 5% & reduce
the
cost of residual uncertainty to $3,000.
Option 3: Invest $4,000 in loss control that would reduce the chance of loss to 2.5% &
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 Spring '12
 Dr.Eastman
 Management, residual uncertainty

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