Reference no: EM13284027

Seward's Go-Carts has annual sales of $150 million with an expected profit of $5 million. It currently has a retention limit for annual liability losses equal to $5 million. The premium for excess insurance coverage above the $5 million retention is $50,000. With the $5 million retention, its expected retained losses for accidents during the year equal $1 million. Half of all retained losses for accidents during the year will be paid at the end of the year; the remaining half will be paid at the end of the next year. If Seward changes its retention level to $2 million, the premium for excess coverage will be $170,000. Its expected retained losses for accidents during the year will drop to $900,000. Again, half of retained losses for accidents during the year will be paid at the end of the year; the remaining half will be paid at the end of the second year. Premiums are paid at the beginning of the year. Seward's opportunity cost of capital is 10%. Tax rate is 34%. The decision horizon is one year of coverage b/c the firm can change its retention level again the following year.

(A) Calculate the present value of the after-tax change in expected net cash flows from reducing Seward's retention level from $5 million to $2 million. (B) Calculate the present value of the after-tax change in net cash flows from reducing Seward's retention level assuming that actual retained losses equal the retention limits rather than the expected values.