A Manufacture ring firm determines that its payout period schedule for worker's compensation is a s follows:
Year Payout %
1 25
2 35
3 40
If the firm insures this exposure, the premium will be $750,000 payable upon inception of the policy. The premium represents 60% loss and 40% administrative expense.
a) Demonstrate and explain if there are any cash flow advantages of detaining this loss of the firm's cost of capital so 7%. Show all calculations and support you recommendation.
b) Identify 2 potential disadvantages of retention.