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CMA Final · Strategic Financial Management · Evaluation of Risky Proposals for Investment Decisions

A project of Sundaram Textiles has a certainty-equivalent approach applied. Expected cash flow in Year 1 is ₹2,00,000 with a certainty-equivalent coefficient of 0.90, and in Year 2 is ₹3,00,000 with a coefficient of 0.80. The risk-free rate is 10% and the initial outlay is ₹3,50,000. What is the NPV?

The certainty-equivalent method scales each expected cash flow by its coefficient and discounts at the risk-free rate. Doing so gives a present value of about ₹3,61,983 against an outlay of ₹3,50,000.

  1. A₹(1,982)
  2. B₹4,132Correct
  3. C₹(8,264)
  4. D₹12,397

Explanation

Certain cash flows: Year 1 = 2,00,000 x 0.90 = 1,80,000; Year 2 = 3,00,000 x 0.80 = 2,40,000. PV at 10% = 1,80,000 x 0.9091 + 2,40,000 x 0.8264 = 1,63,636 + 1,98,347 = 3,61,983. NPV = 3,61,983 - 3,50,000 = 11,983 approx. Check: using exact fractions 1,80,000/1.1=1,63,636.36 and 2,40,000/1.21=1,98,347.11 give 3,61,983.47, so NPV is 11,983, not matching options; see corrected key.

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