Transcript Document

ARM 54 Review Session
April 27, 2014 · Denver, CO
Michael W. Elliott, CPCU, AIAF
Susan Kearney, CPCU, ARM, AAI, AU
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Page 1
Session Overview
• Exam Basics – What to Expect
• Test Taking Tips
• Review of the “Top” Most Challenging Educational
Objectives of ARM 54
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Page 2
Exam Basics – What to Expect
•Exam Length, Exam Format
•Educational Objectives
•Balanced Exam
•Formulas and Tables
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Page 3
Test Taking Tips
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Don’t get bogged down early
Try the exam in “waves”
Get the easy ones
Eliminate the obviously wrong answers
Use the mark for later review feature
Use your scratch paper to keep track
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Page 4
Risk Management Principles and Practices
Segment A
● Intro to Risk Mgt.
Segment B
Segment C
● Risk Mgt. Framework
● Financial Statement
Risk Analysis
● Risk Mgt. Standards
and Guidelines
and Process
● Hazard Risk
● Risk Analysis
● Operational,
Financial and Strategic
Risk
● Risk Treatment
● Risk Identification
● Capital Investment
and Financial Risk
● Monitoring and
Reporting on Risk
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Page 5
Assignment 1: Introduction to Risk
Management
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•
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The Risk Management Environment
Benefits of Risk Management
Risk Management Objectives and Goals
Basic Risk Measures
Risk Classifications
Enterprise Risk Management
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Page 6
Classifications of Risk
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Page 7
Risk Quadrants
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Page 8
Risk can be classified as diversifiable or nondiversifiable. Which
one of the following statements is true with respect to this type
of risk classification?
 A: Inflation, unemployment, and natural disasters, such as
hurricanes, are examples of diversifiable risk.
 B: Diversifiable risks tend not to be correlated so they can be
managed through diversification or spread of risk.
 C: The distinction between diversifiable and nondiversifiable
risks is clear; risks cannot fall under both classifications
simultaneously.
 D: Private insurance tends to concentrate on nondiversifiable
risks; government insurance is often suitable for diversifiable
risks.
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Page 9
Assignment 2: Risk Management
Standards and Guidelines
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Page 10
Risk Management Standards
• Standards
• Frameworks
• Major risk management standards and guidelines
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Page 11
Framework and Process
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Page 12
ISO 31000 Framework and Process
Source: ISO
31000:2009
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Page 13
COSO ERM
Source: COSO – Enterprise Risk Management – Integrated Framework
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Page 14
A key distinction between ISO 31000 and COSO ERM is
that ISO 31000
A: takes an enterprise-wide approach.
B: involves elements of a risk management process.
C: defines “risk” as having both an upside and a
downside.
D: requires the monitoring of treatment plans.
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Page 15
The Committee of Sponsoring Organizations’ (COSO
2004) risk management standard
 A: primarily employs root cause analysis to assess
risk.
 B: defines “risk” as the uncertainty on objectives.
 C: was issued by a government agency.
 D: originated with a focus on financial risk.
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Page 16
Assignment 3: Hazard Risk
• The Nature of Hazard Risk
• Loss Exposures
• Commercial Insurance Policies
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Page 17
A group of female employees at Third Federal Bank filed a
lawsuit against the bank. The lawsuit alleges that the
bank consistently failed to promote qualified women to
senior management positions because of their gender. If
the lawsuit is successful, which one of the following
coverages would pay the damage award?
 A: Workers compensation insurance
 B: Sistership liability insurance
 C: Employment practices liability insurance
 D: General liability insurance
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Page 18
Assignment 4: Operational,
Financial, and Strategic Risk
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Page 19
Operational Risk
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•
•
•
People
Process
Systems
External events
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Page 20
Risk Indicator
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Page 21
Financial Risks
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Market risk
Currency price risk
Interest rate risk
Commodity price risk
Equity price risk
Liquidity risk
Credit risk
Price risk
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Page 22
Which one of the following types of financial
risk measures an organization’s ability to raise
cash?
A: Price risk
B: Market risk
C: Liquidity risk
D: Interest rate risk
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Page 23
Value at Risk (VaR)
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Page 24
A $500,000, 2 percent VaR means losses are
expected to be
A: $10,000.
B: less than $500,000 2 percent of the time.
C: $490,000.
D: greater than $500,000 2 percent of the time.
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Page 25
Earnings at Risk
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Page 26
Earnings at risk of $200,000 with 90 percent confidence
are projected to be
A: $180,000.
B: less than $200,000 10 percent of the time.
C: $200,000 90 percent of the time.
D: greater than $200,000 10 percent of the time.
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Page 27
EO 4.06
Apply the concept of economic capital to
insurers.
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Page 28
Market Value Surplus (MVS)
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Page 29
Economic Capital
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Page 30
Market Value Surplus Example
Autumn Assurance Group has assets at fair value of $100
million. The present value of Autumn’s liabilities is $85
million. The market value margin is $5 million. Using
probability models, Autumn determines that its VaR is $8
million because it expects to incur an $8 million or greater
loss of capital at a .5 percent probability over a one-year
period.
1. What is Autumn’s MVS?
2. What is Autumn’s economic capital?
3. Does Autumn have excess capital or a deficiency in
capital?
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Page 31
Risk Management Principles and Practices
Segment A
● Intro to Risk Mgt.
Segment B
Segment C
● Risk Mgt. Framework
● Financial Statement
Risk Analysis
● Risk Mgt. Standards
and Guidelines
and Process
● Hazard Risk
● Risk Analysis
● Operational,
Financial and Strategic
Risk
● Risk Treatment
● Risk Identification
● Capital Investment
and Financial Risk
● Monitoring and
Reporting on Risk
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Page 32
Assignment 5: Risk Management Framework and
Process
ERM Framework and Process Model
Traditional RM Process
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Page 33
Cromley has 30 stores located throughout the U.S. An increase
in the frequency and severity of general liability claims over
the last three years has encouraged Cromley's risk manager
to design and implement a risk management framework
and process. Cromley has decided to replace the carpeting
at several locations, purchase additional storage
equipment, and train employees on premises safety.
Cromley is in which one of the following stages of designing
and implementing a risk management framework and
process?
 A: Evaluation of internal and external environments
 B: Gap analysis
 C: Integration into existing processes
 D: Commitment of resources
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Page 34
Assignment 6: Risk Identification
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•
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Introduction to Risk Identification
Team Approaches to Risk Identification
Risk Registers
Risk Maps
Identifying Loss Exposures
Identifying Risk
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Page 35
Which one of the following team approaches to risk
identification involves a select group of experts in
question-and-response cycles until a consensus is
achieved?
A: Delphi technique
B: SWOT analysis
C: HAZOP
D: Scenario analysis
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Page 36
Assignment 7: Risk Analysis
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Page 37
EO 7.03
Describe the following characteristics of
probability distributions:
• Expected value
• Mean
• Standard deviation
• Coefficient of variation
• Normal distribution
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Page 38
Probability Distributions
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Page 39
Frequency Probability Distribution
Number of Hurricanes
Probability
0
.300
1
.350
2
.200
3
.147
4
.002
5
.001
Total
1.00
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Page 40
Characteristics of Probability Distributions
Central Tendency
• Expected Value
• Mean
Dispersion (volatility)
• Standard Deviation
• Coefficient of Variation
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Copyright 2011 American Institute for Charter Property Casualty
Underwriters/Insurance Institute of America. All rights reserved
Page 41
Central Tendency
Number of
Hurricanes
Probability
Expected
Value
0
30 %
0.00
1
35 %
.350
2
20 %
.400
3
14.7 %
.441
4
.02 %
.008
5
.01 %
.005
15
100 %
1.204
Mean
15/6 = 2.5
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Copyright 2011 American Institute for Charter Property Casualty
Underwriters/Insurance Institute of America. All rights reserved Page 42
Dispersion
Standard Deviation – Measures dispersion of the values
in a probability distribution and the mean of that
distribution.
Coefficient of Variation – Standard deviation divided by
the mean of a distribution.
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Copyright 2011 American Institute for Charter Property Casualty
Underwriters/Insurance Institute of America. All rights reserved
Page 43
Normal Distribution
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Copyright 2011 American Institute for Charter Property Casualty
Underwriters/Insurance Institute of America. All rights reserved
Page 44
Assume that the length of time a heating element can operate
safely conforms to a normal distribution with a mean of 5,000
hours and a standard deviation of 1,000 hours. If the element is
replaced after 5,000 hours, which one of the following
represents the chance that the heating element will become
unsafe before being replaced?
A: 70 percent
B: 50 percent
C: 40 percent
D: 20 percent
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Page 45
If 95.44 percent of all outcomes are within two standard
deviations above and below the mean and 2.15 percent of all
outcomes are between two and three standard deviations
above and 2.15 percent of all outcomes are between two and
three standard below the mean, the percentage of all
outcomes that lie beyond three standard deviations from
(above and below) the mean is
A: .13
B: .26
C: 2.15
D: 4.30
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Page 46
Coefficient of Variation Example
A plant manager wants to compare the relative variability of the
plants workers’ compensation frequency to its severity. Based on
the data below, is the plant’s frequency or severity relatively
more variable?
Frequency
Severity
Mean
Standard
Deviation
40
10
$90,000
$45,000
Coefficient of
Variation
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Copyright 2011 American Institute for Charter Property Casualty
Underwriters/Insurance Institute of America. All rights reserved
Page 47
EO 7.04
Explain how regression analysis can be used
to forecast gains and losses.
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Page 48
Regression Analysis Equation
y = a + b(x)
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Page 49
Decision Tree
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Page 50
Vandenberg ‘s risk manager uses regression analysis to determine
the relationship between Vandenberg’s workers compensation
medical expenses (the dependent variable) and its payroll (the
independent variable). The formula for Vandenberg’s linear
regression line is y = 5.20 + .098 (x). Next year’s payroll is estimated
to equal $3,750,000. Based on this information what are
Vandenberg’s estimated workers compensation medical expenses
next year?
A: $367,495
B: $367,500
C: $367,505
D: $375,520
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Page 51
Assignment 8: Risk Treatment
•Risk Treatment
•Introduction to Risk Financing
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Page 52
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Page 53
The CEO of GBB Co.,in consultation with the head of the human
resources department, decided to begin to offer off-site day
care as an employee benefit for GBB employees. The risk
manager learned of the day care operation two weeks after
the service to employees had begun. He reviewed the
company's liability insurance contracts and determined that
the company had no coverage for liability arising out of the
day care operations. This risk, as it was not identified and
treated, is being handled through




A: Unplanned transfer.
B: Unplanned mitigation.
C: Unplanned avoidance.
D: Unplanned retention.
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Page 54
Risk Management Principles and Practices
Segment A
● Intro to Risk Mgt.
Segment B
Segment C
● Risk Mgt. Framework
● Financial Statement
Risk Analysis
● Risk Mgt. Standards
and Guidelines
and Process
● Hazard Risk
● Risk Analysis
● Operational,
Financial and Strategic
Risk
● Risk Treatment
● Risk Identification
● Capital Investment
and Financial Risk
● Monitoring and
Reporting on Risk
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Page 55
Assignment 9: Financial Statement
Risk Analysis
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Page 56
Balance Sheet
Assets
Current Assets
Noncurrent Assets
Total Assets
Liabilities and Shareholders’ Equity
Current Liabilities
Noncurrent Liabilities
Total liabilities
Shareholders’ Equity
Total Liabilities and Shareholders’
Equity
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Page 57
Income Statement
Revenue
- Cost of goods sold
Gross profit
- General operating expenses
Operating income
+/- Other income/expenses
Net income before taxes
- Income taxes
Net Income
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Page 58
Statement of Comprehensive Income
Net income +
Other comprehensive income (OCI)
Components of OCI
Change in unrealized appreciation/depreciation of
investments
Foreign currency gains/losses
Minimum pension liability changes
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Page 59
EO 9.04
Describe the content and purpose of the
statement of changes in shareholders’ equity
and the statement of cash flows.
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Page 60
Owners’ Equity (OE)
OE Components
Paid-in capital
Retained earnings
Accumulated other
comprehensive income
Treasury stock
Change in OE (year over year)
+ common stock issued
+ net income – dividends
+/- other comprehensive
income/loss
+/- share issuance/ repurchase
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Page 61
The portion of net income that is not distributed
to stockholders is added to
A: comprehensive income.
B: retained earnings.
C: treasury stock.
D: paid-in capital.
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Page 62
Statement of Cash Flows
Operating activities
Investing activities
Financing activities
Increase/decrease in cash for year
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Page 63
EO 9.06
Apply trend analysis to income statements
over multiple periods.
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Page 64
Trend Analysis
Revenue
12/31/2013
12/31/2012
12/31/2011
$25,000
$30,000
$33,000
$1,500
$1,800
Net income $1,200
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Page 65
Lisa wants to quantify her company’s sales growth rate over the
past year. Using the following data, what is the growth rate?
End Yr. 2
End Yr. 1
Net Sales
$500,300 $450,200




A: 8 percent.
B: 9 percent.
C: 10 percent.
D: 11 percent.
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Page 66
Which one of the following statements best describes a trend in the financial
data above?
 A: The low growth in the cost of sales is adversely affecting gross profit.
 B: Operating profit is negative during each of these three years.
 C: Operating expenses are increasing at a faster rate than sales causing
operating profit to decline.
 D: The cost of sales is increasing at a faster rate than operating expenses.
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Page 67
EO 9.07
Explain how ratio analysis can be used to
evaluate liquidity.
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Page 68
Ratio Analysis
Working capital
current assets – current liabilities
Current ratio
current assets / current liabilities
Acid-test ratio
(cash + marketable securities +
accounts receivable) / current
liabilities
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Page 69
Balance Sheet
Current Assets
Cash
$50,000
A/R
125,000
Inventory
1,500,000
Supplies
75,000
Securities
15,000,000
Total
$16,750,000
Current Liabilities
Accts payable
Wages payable
Taxes payable
ST debt
Total
$1,250,000
250,000
3,750,000
15,000,000
$20,250,000
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Page 70
Assignment 10: Capital Investment
and Financial Risk
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Page 71
EO 10.04
Calculate the net present value of a series of
cash outflows and inflows, given the
applicable rate of return and number of
periods.
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Page 72
Present Value Considerations
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•
•
•
•
•
Single or multiple periods?
Single or multiple sums?
Equal or unequal amounts for each period?
Cash inflows, outflows, or both?
How many periods (n)?
What is the interest rate (r)?
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Page 73
Present Value Formula
PV = FVn ÷ (1 +
n
r)
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Page 74
ABC Insurance’s financial officer wants to set aside
sufficient funds to pay a lump sum claim settlement of
$250,000 two years from today. Assuming the fund earns
10 percent per year, how much will the financial officer
need to place in the fund today?
A: $375,000
B: $302,500
C: $225,000
D: $206,600
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Page 75
Present Value of $1 Table
n/r
8%
9%
10%
1
.9259
.9174
.9091
2
.8573
.8417
.8264
3
.7938
.7722
.7513
4
.7350
.7084
.6830
5
.6806
.6499
.6209
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Page 76
Present Value of an Annuity
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Page 77
Present Value of an Annuity of $1 Table
n/r
5%
6%
7%
8%
1
.9524
.9434
.9346
.9259
2
1.8594
1.8334
1.8080
1.7833
3
2.7232
2.6730
2.6243
2.5771
4
3.5460
3.4651
3.3872
3.3121
5
4.3295
4.2124
4.1002
3.9927
6
5.0757
4.9173
4.7665
4.6229
7
5.7864
5.5824
5.3893
5.2064
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Page 78
EO 10.05
Evaluate capital investment proposals using
the net present value method.
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Page 79
Net Present Value (NPV)
The present value of all future net cash flows
(including salvage value) discounted at the
cost of capital, minus the cost of the initial
investment, also discounted at the cost of
capital.
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Page 80
Net Present Value of an Investment
Year
Payment
Present Value
Factor (7%)
0
-$10,000
1.0000
-$10,000
1
2,500
.9346
2,236
2
3,300
.8734
2,882
3
$4,700
.8163
3,837
Net present value
Present Value
-$945
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Page 81
Net Present Value Example
Should your company invest $10,000 today in loss control equipment
that is expected to save losses and expenses of $3,000 at the end of
the first year, $3,200 at the end of the second year, and $4,100 at the
end of the third year. Assume your company requires a rate of return
on its investments of 5 percent.
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Page 82
Risk Information System – NPV
•
•
•
•
•
Initial investment = $30,000
Useful life = 7 years
Operating expenses $600 per year
Savings = $12,000 per year
Expected rate of return = 8%
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Page 83
Risk Information System – NPV
Revenue
Expenses
Before-tax CF
Tax
After-tax CF
X
PV of AT CF
Initial invest.
NPV
$12,000
(600)
11,400
(2,846)
8,554
5.206
44,532
(30,000)
$14,532
Before-tax CF
Depreciation
Taxable income
Tax (40%)
$11,400
(4,286)
7,114
$2,846
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Page 84
Omicron Manufacturing is considering the purchase of new
extrusion equipment that costs $150,000 and has a useful life of
10 years with no salvage value. It will generate differential cash
revenues of $35,000 per year and will add $4,000 to the
company’s annual maintenance costs and $1,500 to its insurance
premium. Omicron uses straight-line depreciation and has a 40
percent tax rate. What is the differential annual after-tax net
cash flow if Omicron purchases the equipment?
 A: $5,800
 B: $11,800
 C: $23,700
 D: $29,500
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Page 85
Assignment 11: Monitoring and Reporting
on Risk
•
•
•
•
Board Risk Oversight
Internal Controls Support to Risk Monitoring
Internal Audit Support to Risk Monitoring
Risk Assurance to Evaluate Risk Management
Performance
• Risk Management Monitoring and Reporting
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Page 86