A project has an expected risky cash flow of $500 in year 3. The risk-free rate is 4%, the expected market rate of return is 14%, and the project's beta is 1.20. Calculate the certainty equivalent cash flow for year 3, CEQ3. (Assume CAPM holds.)

1 answer
Question:

A project has an expected risky cash flow of $500 in year 3. The risk-free rate is 4%, the expected market rate of return is 14%, and the project's beta is 1.20. Calculate the certainty equivalent cash flow for year 3, CEQ3. (Assume CAPM holds.)

Answers

The certainty equivalent cash flow for year 3, CEQ3 is $360.33The computation of the certainty equivalent cash flow for year 3 is as follows:But before that, the cost of equity should be determined via using the Capital Asset Pricing Model (CAPM).Cost of equity = Risk-free rate + beta × (expected market rate of return - risk-free rate)= 4% + 1.20 × (14% - 4%)= 16%Now the certainty equivalent cash flow for year 3 is= $500 ÷ (1+ 0.16)^3= $360.33Therefore we can conclude that the certainty equivalent cash flow for year 3, CEQ3 is $360.33Learn more about the CAPM here: brainly.com/question/14531617

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