Chapter 13, Problem 20BEA

1.

To determine

Compute inherent risk.

Answer to Problem 20BEA

Inherent risk is $24,000,000.

Explanation of Solution

Inherent Risk:

Inherent risk is a risk that prevails in a system before any control measure is adopted within an organization.

Computation of inherent risk:

Inherent risk can be computed by using the following formula:

$\text{Inherent}\text{risk}=\text{Impact}\times \text{Probability}\text{of}\text{occurrance}$

Substitute $80,000,000 for impact and 30% for the probability of occurrence in the above formula.

$\begin{array}{c}\text{Inherent}\text{risk}=\$80,000,000\times 30\%\\ =\$24,000,000\end{array}$

Therefore, inherent risk is $24,000,000.

2.

To determine

Compute residual risk of each of the three alternatives.

Answer to Problem 20BEA

Residual risk for alternative A, B, and C is $16,000,000, $7,500,000, and $24,000,000 respectively.

Explanation of Solution

Residual risk can be computed by using the following formula:

$\text{Residual}\text{risk}=\text{Impact}\times \text{Probability}\text{of}\text{occurrance}$

Computation of residual risk for alternative A:

Substitute $80,000,000 for impact and 20% for the probability of occurrence in the above formula.

$\begin{array}{c}\text{Residual}\text{risk}=\$80,000,000\times 20\%\\ =\$16,000,000\end{array}$

Computation of residual risk for alternative B:

Substitute $50,000,000 for impact and 15% for the probability of occurrence in the above formula.

$\begin{array}{c}\text{Residual}\text{risk}=\$50,000,000\times 15\%\\ =\$7,500,000\end{array}$

Computation of residual risk for alternative C:

Substitute $80,000,000 for impact and 30% for the probability of occurrence in the above formula.

$\begin{array}{c}\text{Residual}\text{risk}=\$80,000,000\times 30\%\\ =\$24,000,000\end{array}$

Therefore, residual risk for alternative A, B, and C is $16,000,000, $7,500,000, and $24,000,000 respectively.

3.

To determine

Compute benefit from each of the three alternatives.

Answer to Problem 20BEA

Benefitfrom alternatives A, B, and C is $8,000,000, $16,500,000, and $0 respectively.

Explanation of Solution

Benefit from a risk response alternative can be computed by using the following formula:

$\text{Benefit}=\text{Inherent}\text{risk}-\text{Residual}\text{risk}$

Computation of response benefit from alternative A:

Substitute $24,000,000 for inherent risk and $16,000,000 for residual risk in the above formula.

$\begin{array}{c}\text{Benefit}=\$24,000,000-\$16,000,000\\ =\$8,000,000\end{array}$

Computation of response benefit from alternative B:

Substitute $24,000,000 for inherent risk and $7,500,000 for residual risk in the above formula.

$\begin{array}{c}\text{Benefit}=\$24,000,000-\$7,500,000\\ =\$16,500,000\end{array}$

Computation of response benefit from alternative C:

Substitute $24,000,000 for inherent risk and $24,000,000 for residual risk in the above formula.

$\begin{array}{c}\text{Benefit}=\$24,000,000-\$24,000,000\\ =\$0\end{array}$

Therefore, benefit from alternatives A, B, and C is $8,000,000, $16,500,000, and $0 respectively.

4.

To determine

Compute net benefit from each of the three alternatives.

Answer to Problem 20BEA

Net benefit from alternatives A, B, and C is $5,000,000, $3,500,000, and $0 respectively.

Explanation of Solution

Net benefit from a risk response alternative can be computed by using the following formula:

$\text{Net}\text{benefit}=\text{Response}\text{benefit}-\text{Response}\text{cost}$

Computation of net benefit from alternative A:

Substitute $8,000,000 for response benefit and $3,000,000 for response cost in the above formula:

$\begin{array}{c}\text{Net}\text{benefit}=\$8,000,000-\$3,000,000\\ =\$5,000,000\end{array}$

Computation of net benefit from alternative B:

Substitute $16,500,000 for response benefit and $13,000,000 for response cost in the above formula:

$\begin{array}{c}\text{Net}\text{benefit}=\$16,500,000-\$13,000,000\\ =\$3,500,000\end{array}$

Computation of net benefit from alternative C:

Substitute $0 for response benefit and $0 for response cost in the above formula:

$\begin{array}{c}\text{Net}\text{benefit}=\$0-\$0\\ =0\end{array}$

Therefore, net benefit from alternatives A, B, and C is $5,000,000, $3,500,000, and $0 respectively.

5.

To determine

Identify the alternative which would be adopted by the company.

Explanation of Solution

Alternative A would be chosen by the company since; net benefit is highest in case of alternative A.