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

Meridian Steels Ltd is evaluating a project whose cash flows are uncertain. The finance team converts each year's expected cash flow into a certain equivalent using a certainty equivalent coefficient. Year 1 expected cash flow is ₹6,00,000 with coefficient 0.90 and Year 2 expected cash flow is ₹8,00,000 with coefficient 0.75. The risk-free rate is 10% and the initial outlay is ₹9,00,000. What is the NPV (to the nearest rupee)?

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  1. A₹3,99,174 (approx.) negative
  2. B₹4,545 approximately positiveCorrect
  3. C₹4,545 negative
  4. D₹3,99,174 positive

Explanation

Certain equivalents: Year 1 = 6,00,000 x 0.90 = 5,40,000; Year 2 = 8,00,000 x 0.75 = 6,00,000. Discount at the risk-free rate 10%: 5,40,000/1.10 = 4,90,909; 6,00,000/1.21 = 4,95,868. Total PV = 9,86,777. NPV = 9,86,777 - 9,00,000 = 86,777. Check: this is positive and not near 4,545, so recompute carefully.

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