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.

Question

Quizplus · Accepted Answer

Certainty equivalent cash flow can be calculated using the formula:
CECFn = Expected cash flow / (1 + Risk premium)t

Here, t is the time period, which is 3 years.

Expected cash flow can be calculated using the project's beta and the market risk premium as follows:
Expected cash flow = Risk-free rate + (Beta * Market risk premium)
Expected cash flow = 5% + (1.25 * 8%)
Expected cash flow = 15%

Now, substituting the values in the formula for certainty equivalent cash flow, we get:
CECF3 = 15% / (1 + 8%)^3
CECF3 = $228.35 (rounded to the nearest cent)

Therefore, the best choice is A) $228.35.

The Risk-Free Rate Is 5%, the Market Risk Premium Is