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Insurance
Insurance-A Comprehensive Study Guide by Ashley Morris
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Terms in this set (20)
Boyce obtains from Capital Insurance Company a policy that provides that if the parties cannot agree on the amount of a loss covered by the policy, an estimate of the value by an impartial third party can be demanded. This is
an appraisal clause.
Dhani is the beneficiary of a life insurance policy on Elmo's life obtained from Famed Insurance Company. The insured under this policy is
Elmo.
Chocolate Gourmet Company obtains an insurance policy to protect against losses incurred by the firm as a result of being held liable for personal injuries or property damage sustained by others. This is
casualty insurance.
Speedy Shipping Corporation applies to TransInsurance Company for a fire insurance policy on Speedy's warehouse. On the application, Speedy misrepresents the age of the property to obtain a lower premium. When a fire soon destroys the warehouse, TransInsurance can
deny payment, because of Speedy's fraud in the application.
International Foods Corporation insures its real and personal property, as well as the lives of its key employees, to protect its financial interest should some event undermine its security. This is
risk management.
Kerin obtains a property insurance policy for her art collection from Lawton Insurance Company. Lawton can cancel the policy
at any time.
For Diana to obtain an insurance policy on Eden Farm, including its crops, equipment, and livestock, she must have an insurable interest in the property that exists
at the time a loss occurs.
General Allied Company obtains insurance policies with Hy-Rate Insurance, Inc., and Ideal InsurCo against the risk of loss of General's office building in a fire. Each policy includes a multiple-insurance clause. A fire partially destroys the building. General can collect from Hy-Rate
its proportionate share of the loss to the total amount of insurance.
EZ Rentals Company wants to insure the equipment that it rents to the public. To obtain insurance, EZ must have an insurable interest in the property
at the time a loss occurs.
Edy obtains a homeowners' insurance policy with First Source Insurance Company. First State can cancel the policy
if Edy fails to pay the premiums.
Bob applies to City Insurance Company for insurance. City issues a policy, but later discovers that Bob's application includes several misstatements. Most likely, these misstatements can
void the policy.
Investors Commercial Property Corporation obtains an insurance policy that protects against any losses incurred as a result of existing claims against or liens on certain property at the time of its purchase. This is
title insurance.
Grace applies for a homeowners' insurance policy on her house with Heroic Insurance Company through Ian, a broker. In this transaction, Ian is
Grace's agent, and not Heroic's agent.
Bret obtains a fire insurance policy on his rental house with Continental Insurance Company. Like all insurance, this policy is an arrangement for
transferring and allocating risk.
Lila obtains a life insurance policy with no cash surrender value and names her son Maurice as the beneficiary. This is
term life insurance.
Dag obtains from Excel Insurance Company a policy that provides that Dag has thirty days after a premium's due date to pay it before the policy will be canceled. This is
an antilapse clause.
Rolling Transport & Storage Corporation wants to insure its warehouse to obtain the maximum possible recovery for the lowest possible premium. To obtain the maximum recovery under a coinsurance clause, the percentage of the value of the property that should be insured is
80 percent.
Dale and Ernie are partners who own and operate Cluck'n Hut, a chain of fast food restaurants. Their partnership obtains insurance on the owners' lives. This is
key-person insurance.
Grover is an accountant with the firm of Hall & Associates, which obtains insurance from Interstate Insurance, Inc, on Grover's life. Grover dies. The proceeds of the policy belong to
Hall & Associates.
Ginny obtains a health insurance policy for her family from Hope Insurance Company. The policy includes an incontestability clause. Under such a clause, after a policy has been in force for two or three years
Hope cannot contest Ginny's statements in the application.
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Verified questions
question
You want to buy a house within 3 years, and you are currently saving for the down payment. You plan to save $9,000 at the end of the first year, and you anticipate that your annual savings will increase by 5% annually thereafter. Your expected annual return is 8%. How much will you have for a down payment at the end of Year 3?
question
You want to buy a house that costs $140,000. You have$14,000 for a down payment, but your credit is such that mortgage companies will not lend you the required $126,000. However, the realtor persuades the seller to take a$126,000 mortgage (called a seller take-back mortgage) at a rate of 5%, provided the loan is paid off in full in 3 years. You expect to inherit $140,000 in 3 years; but right now all you have is$14,000, and you can afford to make payments of no more than $22,000 per year given your salary. (The loan would call for monthly payments, but assume end-of-year annual payments to simplify things.) a. If the loan was amortized over 3 years, how large would each annual payment be? Could you afford those payments? b. If the loan was amortized over 30 years, what would each payment be? Could you afford those payments? c. To satisfy the seller, the 30-year mortgage loan would be written as a balloon note, which means that at the end of the third year, you would have to make the regular payment plus the remaining balance on the loan. What would the loan balance be at the end of Year 3, and what would the balloon payment be?
question
A strip mall in Dallas has store spaces in several different sizes. There are eight 300-square-foot stores, one 800-square foot store, and one 900- square-foot store. Two of the 300 -square foot stores are vacant. The others are occupied. What is the ratio of vacant space to occupied space? What percent of the space is occupied?
question
Your division is considering two projects. Its WACC is 10%, and the projects’ after-tax cash flows (in millions of dollars) would be as follows: $$ \begin{matrix} \text{ } & \text{0} & \text{1} & \text{2} & \text{3} & \text{4}\\ \text{Project A} & \text{- \$ 30} & \text{\$ 5} & \text{\$ 10} & \text{\$ 15} & \text{\$ 20}\\ \text{Project B} & \text{- \$ 30} & \text{\$ 20} & \text{\$ 10} & \text{\$ 8} & \text{\$ 6}\\ \end{matrix} $$ a. Calculate the projects’ NPVs, IRRs, MIRRs, regular paybacks, and discounted paybacks. b. If the two projects are independent, which project(s) should be chosen? c. If the two projects are mutually exclusive and the WACC is 10%, which project(s) should be chosen? d. Plot NPV profiles for the two projects. Identify the projects’ IRRs on the graph. e. If the WACC was 5%, would this change your recommendation if the projects were mutually exclusive? If the WACC was 15%, would this change your recommendation? Explain your answers. f. The crossover rate is 13.5252%. Explain what this rate is and how it affects the choice between mutually exclusive projects. g. Is it possible for conflicts to exist between the NPV and the IRR when independent projects are being evaluated? Explain your answer. h. Now look at the regular and discounted paybacks. Which project looks better when judged by the paybacks? i. If the payback was the only method a firm used to accept or reject projects, what payback should it choose as the cutoff point, that is, reject projects if their paybacks are not below the chosen cutoff? Is your selected cutoff based on some economic criteria, or is it more or less arbitrary? Are the cutoff criteria equally arbitrary when firms use the NPV and/or the IRR as the criteria? Explain. j. Define the MIRR. What’s the difference between the IRR and the MIRR, and which generally gives a better idea of the rate of return on the investment in a project? Explain. k. Why do most academics and financial executives regard the NPV as being the single best criterion and better than the IRR? Why do companies still calculate IRRs?
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