Year Net Cash Flow Certainty-equivalent 1 $15 million 0.90 2 13 million 0.75 3 1

Question

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

       $20,083,000
       $ 6,628,400
       $13,905,000
       $ 3,019,400

For Ejection Air Seats Airlines new project, the initial outlay 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 14% and the risk-free rate is 6%. Bull uses the certainty-equivalent approach in evaluating above-average risk investments such as this one. What is the project's certainty-equivalent NPV? (Points : 3)

Explanation / Answer

COmpute the certainty equivalent NPV:

Therefore, the Net present value = 3,026,608. Nearly equal to the Option D.

Thus, the correct answer is option D.

Net cash flow Certainity Equivalent Cash Flows Discount @14% Present value of Cash Flows -22 1 -22 1 -22 15 0.9 13.5 0.877193 11.8421053 13 0.75 9.75 0.769468 7.5023084 11 0.55 6.05 0.674972 4.08357767 9 0.3 2.7 0.59208 1.59861675 Net Present Value 3.02660809 Net cash flow Certainity Equivalent Cash Flows Discount @14% Present value of Cash Flows -22 1 -22 1 -22 15 0.9 13.5 0.877193 11.8421053 13 0.75 9.75 0.769468 7.5023084 11 0.55 6.05 0.674972 4.08357767 9 0.3 2.7 0.59208 1.59861675 Net Present Value 3.02660809

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