Question

With uncertain future cash receipts, the manager decides to adjust them with the appropriate certainty equivalent factor. The company has a cost of capital of 10%. The risk-free rate is 8%. Find the certainty cash flow for year 1 of this option: 30% of $7.5 million, 50% of $15.5 million and 20% of $4 million.

____

- $10.603 million
- $9.908 million
- $11.08 million
- $9.64 million

Hint: α_{t} = PVIF(RADR, t)/PVIF(R_{F}, t)

Answer #1

Certainity Equivalent Factor = PVIF(10%,1) / PVIF(8%,1)

= 0.90909091 / 0.92592593

= 0.981818178

Expected Cash Flows = [$7.5 million * 30%] + [$15.5 million * 50%] + [$4 million * 20%]

= $2.25 million + $7.75 million + 0.8 million

= $10.8 million

Certain Cash Flows = Expected Cash Flows * Certainity Equivalent Factor

= $10.8 million * 0.981818178

= $10.6036363 million

Therefore, Certain cash flow for year 1 for this option is $10.603 million

**Option A** is correct

With uncertain future cash inflows,
the manager decides to adjust them with the appropriate certainty
equivalent factor. The certainty cash flow at year 3 is
$8.85 million derived from an investment project with 30% of $7.5
million, 40% of $15.5 million and 30% of $4
million. Given a cost of capital of 6%, what is the
underlying risk-free rate?
____
3.0%
2.5%
2.0%
Undetermined
Hint: αt = PVIF(RADR,
t)/PVIF(RF, t)

QUESTION THREE
Hezborn has the choice to accept a guaranteed $10 million cash
flow or an option with the following;
A 30% chance of receiving $7.5 million
A 50% chance of receiving $15.5 million
A 20% chance of receiving $4 million
Calculate expected cash
flow.
[6 marks]
Assume the risk-adjusted rate of
return used to discount this option in 12% and the risk-free rate
is 3%. This, the risk premium is (12% - 3%) or 9%
(show the workings)
Using...

Delta airlines case study
Global strategy. Describe the current global
strategy and provide evidence about how the firms resources
incompetencies support the given pressures regarding costs and
local responsiveness. Describe entry modes have they usually used,
and whether they are appropriate for the given strategy. Any key
issues in their global strategy?
casestudy:
Atlanta, June 17, 2014. Sea of Delta employees and their
families swarmed between food trucks, amusement park booths, and
entertainment venues that were scattered throughout what would...

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