Question

The Candy Company's Chief Risk Officer has been told of two individual risk scenarios that are concerning.

- A change in regulations that will eliminate 25% of the company's revenue

- An increase in reinsurance costs that will decrease the company's profit margin by 25%

1. Assuming revenues are $100 million prior to the realization of the risk, what would revenues be in millions if both risks were realized at the same time?

A) 100 B) 75 C) 25 D) Cannot be determined

2. Assume that only risk 2 becomes a reality and that the profit margin is 10%. How much profit would the company realize?

A) 10 B) 75 C) 7.5 D) 5.63

Answer 1

Answer 1:

Correct answer is:

B) 75

Explanation:

Revenues prior to the realization of the risk = $100 million

Risks are:

• A change in regulations that will eliminate 25% of the company's revenue
• An increase in reinsurance costs that will decrease the company's profit margin by 25%

If both risks were realized at the same time, revenues will be impacted by the first risk only. As the second risk impacts expenses and hence profit.

Hence:

Revenue if both risks were realized at the same time = $100 - 100 * 25% = $75 million

Hence option B is correct and other options A, C and D are incorrect.

Answer:

Correct answer is:

C) 7.5

Explanation:

Only risk 2 becomes a reality.

Revenue realized = $100 million

As risk 2 becomes a reality, profit = (100 * 10%) * (1 - 25%) = $7.5 million

Hence option C is correct and other options A, B and D are incorrect.