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FM CE approach in capital budgeting

05 March 2018

if the Cash flows from a project with return of 15% is rs. 90L
and the risk free rate is 4% and risk premium is 9%, then what is the Certainty equivalent?

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6 Replies

Divakar (Student CA Final ) (11857 Points)
Replied 05 March 2018

Certainty equivalent cash flow = expected cash flow / (1 + risk premium)

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Kashish Jain (60 Points)
Replied 05 March 2018

so the answer should be
90L÷(1.9) ??

Kashish Jain (60 Points)
Replied 05 March 2018

the answer is
90L÷(1.11)
I don't know how it's come

Divakar (Student CA Final ) (11857 Points)
Replied 05 March 2018

Risk premium here=adjusted rate of return -RF i. e 15%-4%=11% ..... So the answer is 90/1.11 and not 90/1.09

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Divakar (Student CA Final ) (11857 Points)
Replied 05 March 2018

Hope now ur query is resolved.... In CE method we take adjusted rate of reretu on which cash flow is discounted .. Here i. e 15 percent.... And risk preprem calculate accordingly

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Divakar (Student CA Final ) (11857 Points)
Replied 05 March 2018

Certainty Equivalent and Cash Flow. The risk premium is calculated as the risk-adjusted rate of return minus the risk-free rate.

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