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

Sundaram Textiles expects a single cash inflow of ₹1,00,000 at the end of Year 1 from a pilot project. Management applies a certainty-equivalent coefficient of 0.80 to this inflow. The risk-free rate is 10% p.a. What is the present value of this inflow under the certainty-equivalent approach?

The present value is ₹72,727. Under the certainty-equivalent approach the risky inflow is first scaled down by the coefficient to ₹80,000 and then discounted at the risk-free rate of 10% for one year, since risk is already handled in the numerator.

  1. A₹72,727Correct
  2. B₹90,909
  3. C₹80,000
  4. D₹66,116

Explanation

The certainty-equivalent cash flow is 1,00,000 × 0.80 = ₹80,000. It is discounted at the risk-free rate: 80,000 / 1.10 = ₹72,727. Using ₹1,00,000 without the coefficient gives ₹90,909, which ignores risk. Leaving the flow undiscounted gives ₹80,000. Discounting for two years gives ₹66,116.

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