Question

An investor has the choice to accept a guaranteed K9 million cash inflow or an option with the following expectations:

- A 30% chance of receiving K7.5 million
- A 45% chance of receiving K15.5 million
- A 25% chance of receiving K4 million

Assume the risk-adjusted rate of return used to discount this
option is 13.75% and the risk-free rate is 3.25%.
** **

- Calculate the expected cash flow of this investment.
- Calculate the certainty equivalent cash
flow.
- If the investor prefers to avoid risk, what guaranteed option
should accept?

Answer #1

**Given,**

**Cash flow 1 (CF _{1}) = K7.5 million**

**Cash flow 2 (CF _{2}) = K15.5
million**

**Cash flow 3 (CF _{3}) = K4 million**

**Probability 1 (P _{1}) = 30% or 0.30**

**Probability 2 (P _{2}) = 45% or 0.45**

**Probability 3 (P _{3}) = 25% or 0.25**

**Risk adjusted rate of return = 13.75%**

**Risk free rate = 3.25%**

**Solution :-**

QUESTION THREE
Hezborn has the choice to accept a guaranteed $10 million cash
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