Which of the following is true of the certainty equivalent approach?
A)It asks the decision makers to consider each forecast cash flow individually and come up with a lower, risk free cash flow that is equally acceptable.
B)It is accomplished by regressing the division's accounting return on equity in previous years against the return on a major stock market index.
C)It selects worst, middle, and best outcomes for each cash flow and computes NPV for a variety of combinations.
D)It models cash flows as random variables and repeatedly calculates NPV.

Question

Which of the following is true of the certainty equivalent approach? ​
A)It asks the decision makers to consider each forecast cash flow individually and come up with a lower, risk free cash flow that is equally acceptable.
B)It is accomplished by regressing the division's accounting return on equity in previous years against the return on a major stock market index.
C)It selects worst, middle, and best outcomes for each cash flow and computes NPV for a variety of combinations.
D)It models cash flows as random variables and repeatedly calculates NPV.

Quizplus · Accepted Answer

The certainty equivalent approach asks decision makers to consider each forecast cash flow individually and come up with a lower, risk-free cash flow that is equally acceptable. This allows decision makers to account for their risk preference and make better financial decisions. The other choices describe different financial analysis methods that are not related to the certainty equivalent approach.

Which of the Following Is True of the Certainty Equivalent