Reference no: EM13762022
Enrico Owns a vintage passenger steam ship. He makes a living from it by taking tourists, all year round, on sight-seeing trips around the local islands.
The ship is valued at $4,032,000 despite being of vintage design and with an estimated life expectancy such that it would become completely destroyed (through sinking or shipwreck) approximately once in every 20 years'. The engine on the ship, being rather old, breaks down approximately twice a month, and. Each time it happens, it costs Enrico around $1,800 in repairs and $15,000 in lost or refunded passenger fares.
Enrico is looking at two contracts (Contract X and Contract Y).
Contract X is for a steam engine servicing arrangement with a local engineer who would perform regular maintenance operations which would reduce the number of engine breakdowns by 50%. Entering into this contract would cost Enrico $200,000 per year.
Contract Y is an insurance contract which would cover the cost of total destruction if the steam ship sank or became shipwrecked. The cost of entering into Contract Y is also $200,000 per year.
REQUIRED (making any necessary assumptions and showing all workings):
a) Calculate the $ annual expected monetary value (EMV) of breakdowns by the steam engine on Enrico's ship.
b) Calculate the $ annual EMV of total destruction of the steam ship from sinking or by shipwreck.
c) Calculate the annual expected savings from entering into Contract X (8 marks) and Contract Y.
d) Offer your views on which of the two contracts offers Enrico the best value for money and EXPLAIN WHY.
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