Corporate Finance (4th Edition) (Pearson Series in Finance) - Standalone book
Corporate Finance (4th Edition) (Pearson Series in Finance) - Standalone book
4th Edition
ISBN: 9780134083278
Author: Jonathan Berk, Peter DeMarzo
Publisher: PEARSON
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Chapter 30, Problem 2P

Genentech’s main facility is located in South San Francisco. Suppose that Genentech would experience a direct loss of $450 million in the event of a major earthquake that disrupted its operations. The chance of such an earthquake is 2% per year, with a beta of –0.5.

  1. a. If the risk-free interest rate is 5% and the expected return of the market is 10%, what is the actuarially fair insurance premium required to cover Genentech's loss?
  2. b. Suppose the insurance company raises the premium by an additional 15% over the amount calculated in part (a) to cover its administrative and overhead costs. What amount of financial distress or issuance costs would Genentech have to suffer if it were not insured to justify purchasing the insurance?
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