A project has an expected risky cash flow of $500, in year-2. The risk-free rate is 4%, the market rate of return is 14%, and the project's beta is 1.2. Calculate the certainty equivalent cash flow for year-2.
A) $622.04
B) $164.29
C) $401.90
D) None of the above

Question

Quizplus · Accepted Answer

The certainty equivalent cash flow is calculated by discounting the risky cash flow using the risk-adjusted discount rate. The risk-adjusted discount rate is calculated as: Risk-free rate + Beta * (Market rate of return - Risk-free rate) = 4% + 1.2 * (14% - 4%) = 16%. The certainty equivalent cash flow is then $500 / (1 + 0.16)^2 = $401.90.

A Project Has an Expected Risky Cash Flow of $500