A project has the following forecasted cash flows:
Cash Flows, $Thousands | |||
C0 | C1 | C2 | C3 |
−100 | +40 | +60 | +50 |
The estimated project beta is 1.5. The market return rm is 16%, and the risk-free rate rf is 7%.
a. Estimate the opportunity cost of capital and the project's PV (using the same rate to discount each cash flow).
b. What are the certainty-equivalent cash flows in each year?
c. What is the ratio of the certainty-equivalent cash flow to the expected cash flow in each year?
d. Explain why this ratio declines.
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