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A has an opportunity to invest $90,000 in a project that is expected to generate annual cash inflows of $60,000 for each of the next three years. The project's beta coefficient implies a discount rate of 12% for this project, based on a risk-free rate of return of 3%.
A is prepared to forego the expected cash flows from this project in return for a guaranteed payment of $50,000 at the end of year 1, $42,000 at the end of year 2 and $30,000 at the end of year 3.
What is the certainty equivalent value of this opportunity to A?
Suggested Answer: B
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4 comments · newest first
LE
Lewis
39 minutes ago
I think I recall that the certainty equivalent is about comparing the guaranteed payments to the expected cash flows. I just need to remember the right formula to use!
ST
Stephaine
5 days ago
I’m a bit confused about how to factor in the beta and the discount rate. Is the 12% the rate I should use for the certainty equivalent?
KA
Kate
10 days ago
This question feels similar to the practice problems we did on discounted cash flows. I think I need to calculate the present value of those guaranteed payments first.
NO
Noble
16 days ago
I remember we discussed certainty equivalents in class, but I'm not sure how to apply it here with the cash flows and discount rate.