Question

A project has the following forecasted cash flows:
Cash flows
C0 C1 C2 C3
(100) 40 60 50
The estimated project beta is 1.5. The market return r m is 16%, and the risk-free rate r f is 7%.
a. Estimate the opportunity cost of capital and the project’s PV (using the same rate to
discount each cash flow).
b. What are the certainty-equivalent cash flows in each year?
c. What is the ratio of the certainty-equivalent cash flow to the expected cash flow in each
year?
d. Explain why this ratio declines.

Answer 1

(aj Oppur tun:ty lost af Capital Rf t (Rm- Rf) Beta Oppurtuntty (ost captal 7t 6-7) 1.5 20.S0 prosect Pv Co t Ci C3 + 13 C2 Prosect pv 60 - lo0 + + U.2o5)2 (1.205 1.20S Proect pv 3.09 13. So 1. = 20. SO 97 Co) Prem?um RISK eslCer tonity Equivalent Cash floo yeax o 00 чо y eor 35. 24 .135 y eax n 46. 58 (1.135)2 year 3 3५. २० 3 (.13 5)

Ce) Roto of Cer toinity Equivalant Cash flowto Cash flow Expected Yar 35. 24 0.28 40 Y Car 2 46.58 D. Year 3 34. 20 0.684 ratio decline becuse t indicote (d) This associated has. less equi valent the risk and high isk n futore Cash flos