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-3.
A) $622.04
B) $360.33
C) $401.90
D) None of the above

Question

Quizplus · Accepted Answer

1. First, we need to calculate the required rate of return for the project using the CAPM formula:

Required rate of return = Risk-free rate + Beta * (Market rate of return - Risk-free rate)
Required rate of return = 4% + 1.2 * (14% - 4%)
Required rate of return = 15.2%

2. Once we have the required rate of return, we can calculate the certainty equivalent cash flow using the formula:

Certainty equivalent cash flow = Expected cash flow / (1 + Required rate of return)^t

For year 3, the expected cash flow is not given, so we cannot calculate the certainty equivalent cash flow. Therefore, the answer is D, None of the above.

The Risk-Free Rate Is 4%, the Market Rate of Return