Great West States Gws Is A Railroad Company Operating in

Juanita Salazar is the risk manager of Great West States railroad company. She is searching for ways to manage the company's risks more economically at the direction of the CEO. A key financial risk is volatile fuel prices, as fuel is 28% of expenses. Juanita also analyzed installing sprinklers, with a $40,000 cost and $25,000 annual cash flow for 3 years. As the company expands, it is concerned about more derailments. Juanita used regression analysis to predict derailments based on miles traveled.

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Great West States Gws Is A Railroad Company Operating in

Uploaded by

Amit Pandey

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Solved: Great West States GWS is a railroad company

operating in

Great West States (GWS) is a railroad company operating in the Western United States. Juanita
Salazar is risk manager of GWS. At the direction of the company's chief executive officer, she is
searching for ways to handle the company's risks in a more economical way. The CEO stressed
that Juanita should consider not only pure risks but also financial risks. Juanita discovered that
a significant financial risk facing the organization is a commodity price risk-the risk of a
significant increase in the price of fuel for the company'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.
Juanita was also asked to determine whether the installation of a new sprinkler system at the
corporate headquarters building would be justified. The cost of the 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.
GWS is considering expanding its routes to include Colorado, New Mexico, Texas, and
Oklahoma. The company is concerned about the number of derailments that might occur.
Juanita ran a regression with "thousands of miles GWS locomotives traveled" as the
independent variable and "number of derailments" as the dependent variable.
Results of the regression are as follows:
Y = 2.31 + .022 X

With the expansion, GWS trains will travel an estimated 640,000 miles next year.
a. With regard to the fuel price risk:
1. Discuss how Juanita could use futures contracts to hedge the price risk.
2. Discuss how a double-trigger, integrated risk management plan could be employed.
b. What is the net present value (NPV) of the sprinkler system project, assuming the rate of
return required by GWS investors is 10 percent?
c. How many derailments should Juanita expect next year, assuming the regression results are
reliable and GWS goes ahead with the expansion plan?