Question

A company is evaluating the use of insurance to mitigate its risk in the event of a market downturn. The company estimates that it has a total risk of a 20% impact on its net income if a market downturn occurs, and the company currently has a net income of $150,000. At what cost should the company take out insurance to mitigate this risk?

a. $25,000 premium
b. $100,000 premium
c. $150,000 premium
d. $200,000 premium or above

Answer 1

A) $25,000 premium

Step-by-step explanation:

If the company believes that they can lose up to 20% of their net income in the event of a market downturn, then their loses can add up to $30,000 (= $150,000 x 20%). In order for them to reduce risk and not lose money, the company can buy an insurance policy and pay a premium that is worth less than $30,000. The only option available that was costs less than $30,000 is option A.