Question

A project has an expected cash flow of $300 in year 3. The risk-free rate is 5%, the market risk premium is 8%, and the project's beta is 1.25. Calculate the certainty equivalent cash flow for year 3, CEQ3. $228.35 $197.25 $300 $270.02

Answer 1

Answer: $228.35

Step-by-step explanation:

The Certainty Equivalent Cashflow is the amount that the project is expected to generate if it were invested in a risk free asset and then discounted at the company's required return.

`= (Expected cashflow * (1 + riskfree rate)^(no. of periods) )/((1 + required return)^(no. of periods) )`

Required return = Risk free rate + beta * market premium

= 5% + 1.25 * 8%

= 15%

Certainty equivalent cash flow

`= (300 * (1 + 0.05)^(3) )/((1 + 0.15)^(3) ) \\\\= 228.35`

= $228.35