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Question:
Suppose that a factory is located in a flood prone area. You have been hired to identify if the
factory owner should increase the factory’s flood protection. Three options are being
considered:
a) Do nothing. Damage from a moderate flood is $10,000 and $25,000 in a severe flood.
b) Perform a moderate amount of flood protection improvements for $15,000. There will be
no damagefrom a moderate flood and $10,000 in damage from a severe flood.
c) Perform an extensive amount of flood protection for $25,000. There will be no damage
frommoderate or severe floods.
The annual flood risk is 0.7 for no flood, 0.2 for a moderate flood, and 0.1 for a severe flood.
Assuming an interest rate of 15% and a 15 year analysis period, What is the standard
deviation of the expected cost of each flood project in problem above? Which option is least
risky?

ANS-
Context header: Disaster Management
Context explanation: Disaster is the natural calamity that occurs in any part of the earth due
to various and unpredictable reason like flood, earthquake, storm and many more. Therefore
managing these calamites from severe damage there is national authority that alarm and
manages these disasters in such a way that minimize the damage effect.
Answer and explanation:
Factory is located on flood prone area. There are three options, the required thing is to choose
the better option for the firm. So let’s analyze all the option and choose the best one.
Given annual flood risk is
For no flood risk is 0.7
Fore moderate flood risk is 0.2
For sever flood risk is 0.1
Option a:
Annual cost of damage of flood is estimated as

Moderate flood cost + sever flood cost

 10000  0.2  25000  0.1
 2000  2500
 $4500
Therefore, when calculating present value of total loss for 15 years is
 4500
 n n n
 r   r   r 
1    1    ...........   1  
 100   100   100 
4500
 1 2 15
 15   15   15 
1    1    ...........   1  
 100   100   100 
 $20313.13
Standard deviation of expected cost is

1
  20313.13
N 1
1
  20313.13
15  1
1
  20313.13
14
 1450
 38.09
Option b:
Moderate flood risk protection amount increased to $15000 but no damage cover up to
$10000. Therefore, annual cost of damage is
 10000  0.1
 $1000
Therefore, when calculating present value of total loss for 15 years is
1000
 n n n
 r   r   r 
1    1    ...........   1  
 100   100   100 
1000
 1 2 15
 15   15   15 
1    1    ...........   1  
 100   100   100 
 $5847.37
So, total present value cost for the year is
 15000  5847.37
 $20847.37
Standard deviation of expected cost is

1
  20847.37 
N 1
1
  20847.37 
15  1
 38.58
Option c:
Cost of damage from flood is $25000
Estimating no damage from moderate and sever flood. Therefore, present value of cost is
$20000
Form above option now this clear that option c is least risky because option c is has minimum
damage cost.
Standard deviation of expected cost is

1
  20000 
N 1
1
  20000
15  1
 37.79