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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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BuyFindarrow_forward

Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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Cost of Insurance Plans

Johnson Company is considering three different time periods for an insurance policy on its main office building. The premiums on a fire insurance policy covering the building for the amount of $2,000,000 on a 1-year, 3-year, and 5-year basis are as follows:

Chapter M, Problem 3C, Cost of Insurance Plans Johnson Company is considering three different time periods for an insurance

In each case, the entire premium for the full term of the policy is payable at the beginning of the year in which the policy is purchased.

Required:

Evaluate the present value of the annual cost of each insurance plan assuming a 12% compounded annual discount rate. Which plan do you recommend? State the savings for the company.

To determine

Determine the present value of annual cost for each insurance plan, and identify the plan which can be recommended.

Explanation

 Annuity: An annuity is referred as a sequence of payment of fixed amount of cash flows that occurs over the equal intervals of time.

Plan 1:

Annual cost of 1-year insurance plan is $4,480.

Plan 2:

Determine the annual cost of 3-year insurance plan, using the present value of annuity due formula, because the premium amount is payable at the beginning of each period.

PVD=Cash flow×(pDn,i)$11,200=Cash flow×(pDn=3,i=12%)$11,200=Cash flow×2.690051Cash flow=$11,2002.690051

Cash flow=$4,163.49

The, annual cost of 3-year insurance plan is $4,163.49.

Plan 3:

Determine the annual cost of 5-year insurance plan, using the present value of annuity due formula, because the premium amount is payable at the beginning of each period

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