Question

**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 above equation, compute the certainty equivalent cash flow. Advise the investor decision to make if he wants to avoid risk. [9 marks]

Answer #1

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...

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: αt = PVIF(RADR, t)/PVIF(RF, t)

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)

A project has an expected risky cash flow of $300, in year t= 3.
The risk-free rate is 5percent, the market risk premium is 8percent
and the project's beta is 1.25. Calculate the certainty equivalent
cash flow for year t=3.

A project has a forecasted cash flow of $128 in year 1 and $139
in year 2. The interest rate is 7%, the estimated risk premium on
the market is 12%, and the project has a beta of .68. If you use a
constant risk-adjusted discount rate, what is:
a. The PV of the project? (Do not round
intermediate calculations. Round your answer to 2 decimal
places.)
Present value
$
b. The certainty-equivalent cash flow in year 1
and year...

A project has a forecasted cash flow of $126 in year 1 and $137
in year 2. The interest rate is 5%, the estimated risk premium on
the market is 11.5%, and the project has a beta of 0.66. If you use
a constant risk-adjusted discount rate, answer the following:
a. What is the PV of the project? (Do not
round intermediate calculations. Round your answer to 2 decimal
places.)
b. What is the certainty-equivalent cash flow
in year 1...

Question 7
You are valuing a company that generated free cash flow of $10
million last year, which is expected to
grow at a stable 3.0% rate in perpetuity thereafter. The company
has no debt and $8 million in cash. The market risk premium is
8.4%, the risk-free rate is 2% and the firm’s beta is 1.4. There
are 50 million shares outstanding. How much is each share worth
according to your valuation analysis?
1.
$2.75
2.
$2.02
3.
$2.07...

The Bull Company, a lawn mower manufacturer, is considering the
introduction of a new model. The initial investment required is $22
million. Net cash flows over the 4-year life cycle and the
corresponding certainty-equivalents of the new model are as
follows:
Year
Net Cash Flow
Certainty-equivalent
1
$15 million
0.90
2
13 million
0.75
3
11 million
0.55
4
9 million
0.30
The firm’s cost of capital is 12% and the risk-free rate is 8%.
Bull uses the certainty-equivalent...

The Bull Company, a lawn mower manufacturer, is considering the
introduction of a new model. The initial investment required is $22
million. Net cash flows over the 4-year life cycle and the
corresponding certainty-equivalents of the new model are as
follows:
Year
Net Cash Flow
Certainty-equivalent
1
$15 million
0.90
2
13 million
0.75
3
11 million
0.55
4
9 million
0.30
The firm’s cost of capital is 12% and the risk-free rate is 8%.
Bull uses the certainty-equivalent...

Finance Question 14. MZG is considering a project that pays CFs
of $3million a year for three years. These cash flows have been
adjusted for risks. Given an expected market return of 13%, market
risk premium of 9%, and a beta of 1.2, what is the NPV of the
project? A. $6.87 million B. $8.32 million C. $6.35 million D. None
of the above Answer: B. use risk-free of 4% as discount rate. CFs
are certainty equivalent. Using CAPM formula...

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