A project has a forecasted cash flow of $125 in year 1 and $136 in year 2. The i

Question

A project has a forecasted cash flow of $125 in year 1 and $136 in year 2. The interest rate is 8%, the estimated risk premium on the market is 11.25%, and the project has a beta of 0.65. If you use a constant risk-adjusted discount rate, what is

The PV of the project? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

The certainty-equivalent cash flow in year 1 and year 2? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

The ratio of the certainty-equivalent cash flows to the expected cash flows in years 1 and 2? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

A project has a forecasted cash flow of $125 in year 1 and $136 in year 2. The interest rate is 8%, the estimated risk premium on the market is 11.25%, and the project has a beta of 0.65. If you use a constant risk-adjusted discount rate, what is

Explanation / Answer

Risk adjusted dicount rate = Risk free rate + Risk Premium

Risk adjusted dicount rate = 8% + 11.25%

Risk adjusted discount rate = 19.25%

a) PV of the project = $125/(1+r)^1 + $136/(1+r)^2

PV = $125/(1+0.1925)^1 + $136/(1+0.1925)^2

PV = $200.45

b) Certainity equivalent cash flow = Cash flow /(1+ Risk premium)

Year 1 = $125/(1+0.1125)

Year 1 = $112.35

Year 2 = $136/(1+0.1125)^2

Year 2 = $109.88

c) The ratio of certainity equivalent cash flows to Expected cash flows:

Year 1 = Certainity equivalent cash flow / Expected cash flow

= $112.35/$125

Ratio = 0.8988:1

Year 2 = $109.88/$136

Ratio = 0.8079:1

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