CA Intermediate · Financial Management and Strategic Management · Investment Decisions
Iyer Pharma is appraising a project costing ₹1,40,000 with a single expected cash inflow of ₹2,00,000 after one year. Management's certainty-equivalent coefficient for this inflow is 0.88 and the risk-free rate is 10%. Using the certainty-equivalent approach, what is the project's NPV?
The NPV is ₹20,000. Under the certainty-equivalent method, the expected inflow is multiplied by 0.88 to give ₹1,76,000, then discounted at the risk-free rate of 10% to ₹1,60,000. Subtracting the ₹1,40,000 outlay leaves a positive NPV of ₹20,000.
- A₹20,000Correct
- B₹41,818
- C₹36,000
- D₹1,60,000
Explanation
Certain cash flow = 2,00,000 × 0.88 = 1,76,000. Discounted at the risk-free rate of 10%: 1,76,000/1.10 = 1,60,000. NPV = 1,60,000 − 1,40,000 = ₹20,000. Discounting the unadjusted ₹2,00,000 gives ₹41,818, which wrongly ignores the risk adjustment.
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