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ADJUSTMENT OF RISK AND UNCERTAINTY IN CAPITAL BUDGETING DECISION Numerical
What is the certainty equivalent (CE) coefficient used for in capital budgeting?
The certainty equivalent coefficient (α) converts uncertain cash flows into certain equivalents by multiplying expected cash flows by a risk-adjustment factor between 0 and 1, where a lower α reflects higher risk.
What is the certainty equivalent cash flow when α = 0.8 and expected cash flow is ₹50,000?
Certainty equivalent cash flow is ₹40,000.
How is the certainty equivalent coefficient (α) mathematically defined?
α = Certain cash flow / Risky (expected) cash flow; a value closer to 1 indicates low risk while a value closer to 0 indicates high risk.
If a project has a risky cash flow of ₹1,00,000 and CE coefficient of 0.9, what is the risk-adjusted cash flow?
Risk-adjusted cash flow is ₹90,000.
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