CHAPTER 4 , ADVANCED TOPICS IN RISK MANAGEMENT 80 CASE APPLICATION Great West States (GWS) is a railroad company operating might occur. Juanita ran a regression with "thousands of in the Western United States. Juanita Salazar is risk manager miles GWS locomotives traveled" as the independent varia varia variable. ble and "number of derailments" as the dependent varia of GWS At the direction of the company's chicf executive of GWS. At the directi officer, she is searching for ways to handle the company's Resuls of the regression are as follows risks in a more economical way. The CEO stressed that Juanita should consider not only pure risks but also finan- cial risks. Juanita discovered that a significant financial risk With the expansion, GWS trains will travel an estimated facing the organization is a commodity price risk-the risk 640,000 miles next year. of a significant increase in the price of fuel for the compa- a with regard to the fuel price risk: ny's locomotives. A review of the company's income and expense statement showed that last year about 28 percent of its expenses were related to fuel oil Y 2.31 +.022X 1. Discuss how Juanita could use futures contracts to hedge the price risk 2. Discuss how a double-trigger, integrated risk Juanita was also asked to determine whether the management plan could be employed. installation of a new sprinkler system at the corporate b. What is the net present value (NPV) of the sprinkler headquarters building would be justified. The cost of the system project, assuming the rate of return required by GWS investors is 10 percent? project would be $40,000. She estimates the project would provide an after-tax net cash flow of $25,000 per year for three years, with the first of these cash flows coming one year after investment in the project. c. How many derailments should Juanita expect next year, assuming the regression results are reliable and GWS goes ahead with the expansion plan? (Hint: Be careful of scale factors when considering the independent variable.) GWS is considering expanding its routes to include Colorado, New Mexico, Texas, and Oklahoma. The com- pany is concerned about the number of derailments that CHAPTER 4 , ADVANCED TOPICS IN RISK MANAGEMENT 80 CASE APPLICATION Great West States (GWS) is a railroad company operating might occur. Juanita ran a regression with "thousands of in the Western United States. Juanita Salazar is risk manager miles GWS locomotives traveled" as the independent varia varia variable. ble and "number of derailments" as the dependent varia of GWS At the direction of the company's chicf executive of GWS. At the directi officer, she is searching for ways to handle the company's Resuls of the regression are as follows risks in a more economical way. The CEO stressed that Juanita should consider not only pure risks but also finan- cial risks. Juanita discovered that a significant financial risk With the expansion, GWS trains will travel an estimated facing the organization is a commodity price risk-the risk 640,000 miles next year. of a significant increase in the price of fuel for the compa- a with regard to the fuel price risk: ny's locomotives. A review of the company's income and expense statement showed that last year about 28 percent of its expenses were related to fuel oil Y 2.31 +.022X 1. Discuss how Juanita could use futures contracts to hedge the price risk 2. Discuss how a double-trigger, integrated risk Juanita was also asked to determine whether the management plan could be employed. installation of a new sprinkler system at the corporate b. What is the net present value (NPV) of the sprinkler headquarters building would be justified. The cost of the system project, assuming the rate of return required by GWS investors is 10 percent? project would be $40,000. She estimates the project would provide an after-tax net cash flow of $25,000 per year for three years, with the first of these cash flows coming one year after investment in the project. c. How many derailments should Juanita expect next year, assuming the regression results are reliable and GWS goes ahead with the expansion plan? (Hint: Be careful of scale factors when considering the independent variable.) GWS is considering expanding its routes to include Colorado, New Mexico, Texas, and Oklahoma. The com- pany is concerned about the number of derailments that