If the risk adjusted discount rate method and the certainty equivalent methods are to give the same results,then the certainty equivalent factor (at)must equal (where rf is the risk-free interest rate,and "k" is the risk adjusted cost of capital) A)(1 + r_f)^t times (1 + k)^t. B)(1 + k)^t divided by (1 + r_f)^t. C)(1 + r_f)^t divided by (1 + k)^t. D)(1 + k)^t minus (1 + r_f)^t.

Question

Quizplus · Accepted Answer

The formula for relating the risk-adjusted discount rate method and the certainty equivalent method is:

C = 1 / (1 + ra)

Where ra is the risk-adjusted discount rate and C is the certainty equivalent factor.

Using the formula for ra:

ra = rf + β * (k - rf)

Where β is the asset's beta and k is the risk-adjusted cost of capital.

Substituting ra into the first formula, we get:

C = 1 / (1 + (rf + β * (k - rf)))

Simplifying:

C = 1 / (1 + β * (k - rf) + rf)

C = (1 + k) / (1 + β * (k - rf) + rf)

So the answer is C, which is (1 + rf)/(1 + k).

If the Risk Adjusted Discount Rate Method and the Certainty