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

Bharat Tools Ltd is evaluating a one-year project that needs an initial outlay of ₹3,75,000. The expected cash inflow at the end of year 1 is ₹5,50,000, and management's certainty-equivalent coefficient for this flow is 0.80. The risk-free rate is 10%. Under the certainty equivalent approach, what is the project NPV?

The NPV is ₹25,000. The expected inflow is first scaled by the 0.80 certainty-equivalent coefficient to ₹4,40,000, then discounted at the 10% risk-free rate to ₹4,00,000. Deducting the ₹3,75,000 outlay leaves ₹25,000.

  1. A₹2,00,000
  2. B₹65,000
  3. C₹25,000Correct
  4. D₹1,25,000

Explanation

The certain-equivalent flow is 5,50,000 × 0.80 = 4,40,000. Discounting at the risk-free rate of 10% gives 4,40,000/1.10 = 4,00,000. NPV = 4,00,000 − 3,75,000 = 25,000. Using the unadjusted flow gives 1,25,000, which ignores the risk adjustment.

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