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Certainty equivalents A project has a forecasted cash flow of $110 in year 1 and $121 in year 2.
The interest rate is 5%, the estimated risk premium on the market is 10%, and the project has a
beta of .5. If you use a constant risk-adjusted discount rate, what is Snap a photo from your
a. The PV of the project? phone to post a question
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b. The certainty-equivalent cash flow in year 1 and year 2? download link
c. The ratio of the certainty-equivalent cash flows to the expected cash flows in years 1 and 2?
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Step 1 of 6
My Textbook Solutions
Certainty Equivalent:

The amount of money somebody would have need with certainty at a point in time to make the
individual indifferent between that certain amount and an amount predictable to be expected
with risk at the same point of time.
Principles of Principles of Principles o
The risk adjusted discount rate is the average return that an investor earns while investing in a Corporate... Corporate...
security. 9th Edition 10th Edition 8th Edition

Beta measures security risk in relation to market risk. When market return varies by 1%, the View all solutions

security return varies by Beta times.

Comment

Step 2 of 6

Compute the risk adjusted discount rate by using the following formula:

Here,

The risk free rate of return is ,

The current market rate of returns is ,

The beta of the stock i is .

Calculate the certainity equivalent as follows:

Comment

Step 3 of 6
 Calculate the risk adjusted discount rate as follows:

Chapter 10, Problem 8Q Bookmark Show all steps: ON

Therefore, risk adjusted discount rate is .

Comment

Step 4 of 6

a.1

Calculate the present value of the project cash flow as follows:

Therefore, the present value of the project from year 1 is .

a.2

Calculate the present value of the project cash flow as follows:

Therefore, the present value of the project from year 2 is .

Comment

Step 5 of 6

b.1

Calculate the certainity equivalent as follows:

Therefore, the certainty of cash flows is .

b.2

Calculate the certainity equivalent as follows:

 Chapter 10, Problem 8Q Bookmark Show all steps: ON

Therefore, the certainty of cash flows is .

Comment

Step 6 of 6

c.1

Calculate the ratio certainty equivalent to expected cash flows for year 1 as follows:

Therefore, the ratio is .

c.2

Calculate the ratio certainty equivalent to expected cash flows for year 2as follows:

Therefore, the ratio is .

Comment

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