Question

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 approach in evaluating
above-average risk investments such as this one. What is the
project’s certainty-equivalent NPV?

$15,305,620 |
||

$6,628,400 |
||

$5,646,320 |
||

$3,848,380 |

Answer #1

**The NPV is computed as shown below:**

**= Initial investment + Present value of future cash
flows**

**Present value is computed as follows:**

**= Future value / (1 +
r)**^{n}

**So, the NPV is computed as follows:**

= - $ 22 million + ($ 15 million x 0.90) / 1.08 + ($ 13 million
x 0.75) / 1.08^{2} + ($ 11 million x 0.55) /
1.08^{3} + ($ 9 million x 0.30) / 1.08^{4}

= - $ 22 million + $ 13.5 million / 1.08 + $ 9.75 million /
1.08^{2} + $ 6.05 million / 1.08^{3} + $ 2.7
million / 1.08^{4}

**= $ 5.646319159 million or $ 5,646,320
Approximately**

Feel free to ask in case of any query relating to this question

The Bull Company, a lawn mower manufacturer, is considering the
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Year
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