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.