Question

In your own words, What is the certainly equivalent approach?

Answer 1

Answer : The approach to deal risks with capital budgeting, in which uncertain cashflows are converted in to certain cashflows to make refrence for the decision maker is called certainty equivalent approach. It is the risk free cashflows approach. While applying this approach, it is the guranteed amount of cash that would yield the same exact expected utility as a given risky asset with absolute certainty.

Formula to calculate certainty equivalent cashflow :

Certainty equivalent cash flow = expected cash flow / (1 + risk premium)