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Problem 13-25 (Algo) Certainty equivalent approach [LO13-1) Sheila Goodman recently received her MBA from the Harvard Business School. She has joined the family business, Goodman Software Products Incorporated, as Vice-President of Finance. She believes in adjusting projects for risk. Her father is somewhat skeptical but agrees to go along with her. Her approach is somewhat different than the risk-adjusted discount rate approach, but achieves the same objective. She suggests that the inflows for each year of a project be adjusted downward for lack of certainty and then be discounted back at a risk-free rate. The theory is that the adjustment penalty makes the inflows the equivalent of risk-less inflows, and therefore a risk-free rate is justified. A table showing the possible coefficient of variation for an inflow and the associated adjustment factor is shown next; Coefficient of Variation 0 -0.25 0.26 0.50 0.51 0.75 0.76 1.00 1.01 1.25 Assume a $173,000 project provides the following inflows with the associated coefficients of variation for each year. Coefficient of Variation 0.11 Year 1 Inflow. $ 39,600 56,500 79,700 61,700 61,700 Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods. Adjustment Factor 0.90 0.80 0.70 0.60 0.50 2 3 4 5 Year 1 2 0.24 0.55 0.79 1.04 a. Fill in the table below: Note: Do not round intermediate calculations. Round "Adjustment Factor" answers to 2 decimal places and other answers to the nearest whole dollar. Adjustment Factor Adjusted Inflow

Problem 13-25 (Algo) Certainty equivalent approach [LO13-1) Sheila Goodman recently received her MBA from the Harvard Business School. She has joined the family business, Goodman Software Products Incorporated, as Vice-President of Finance. She believes in adjusting projects for risk. Her father is somewhat skeptical but agrees to go along with her. Her approach is somewhat different than the risk-adjusted discount rate approach, but achieves the same objective. She suggests that the inflows for each year of a project be adjusted downward for lack of certainty and then be discounted back at a risk-free rate. The theory is that the adjustment penalty makes the inflows the equivalent of risk-less inflows, and therefore a risk-free rate is justified. A table showing the possible coefficient of variation for an inflow and the associated adjustment factor is shown next; Coefficient of Variation 0 -0.25 0.26 0.50 0.51 0.75 0.76 1.00 1.01 1.25 Assume a $173,000 project provides the following inflows with the associated coefficients of variation for each year. Coefficient of Variation 0.11 Year 1 Inflow. $ 39,600 56,500 79,700 61,700 61,700 Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods. Adjustment Factor 0.90 0.80 0.70 0.60 0.50 2 3 4 5 Year 1 2 0.24 0.55 0.79 1.04 a. Fill in the table below: Note: Do not round intermediate calculations. Round "Adjustment Factor" answers to 2 decimal places and other answers to the nearest whole dollar. Adjustment Factor Adjusted Inflow

EBK CFIN
EBK CFIN
6th Edition
ISBN:9781337671743
Author:BESLEY
Publisher:BESLEY
Chapter10: Project Cash Flows And Risk
Section: Chapter Questions
Problem 20PROB
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Problem 13-25 (Algo) Certainty equivalent approach [LO13-1] Sheila Goodman recently received her MBA from the Harvard Business School. She has joined the family business, Goodman Software Products Incorporated, as Vice-President of Finance. She believes in adjusting projects for risk. Her father is somewhat skeptical but agrees to go along with her. Her approach is somewhat different than the risk-adjusted discount rate approach, but achieves the same objective. She suggests that the inflows for each year of a project be adjusted downward for lack of certainty and then be discounted back at a risk-free rate. The theory is that the adjustment penalty makes the inflows the equivalent of risk-less inflows, and therefore a risk-free rate is justified. A table showing the possible coefficient of variation for an inflow and the associated adjustment factor is shown next: Coefficient of Variation 0 0.25 8.26 0.50 0.51 -0.75 0.76 1.00 1.01 1.25 Year 1 Assume a $173,000 project provides the following inflows with the associated coefficients of variation for each year. Coefficient of Variation 0.11 0.24 0.55 0.79 1.04 Adjustment Factor 0.90 Inflow $ 39,600 56,500 79,700 61,700 61,700 Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods. a. Fill in the table below. Note: Do not round intermediate calculations. Round "Adjustment Factor" answers to 2 decimal places and other answers to the nearest whole dollar. 2 3 4 15 0.80 0.70 0.60 e.se Year 1 2 3 Adjustment Factor Adjusted Inflow
Transcribed Image Text:Problem 13-25 (Algo) Certainty equivalent approach [LO13-1] Sheila Goodman recently received her MBA from the Harvard Business School. She has joined the family business, Goodman Software Products Incorporated, as Vice-President of Finance. She believes in adjusting projects for risk. Her father is somewhat skeptical but agrees to go along with her. Her approach is somewhat different than the risk-adjusted discount rate approach, but achieves the same objective. She suggests that the inflows for each year of a project be adjusted downward for lack of certainty and then be discounted back at a risk-free rate. The theory is that the adjustment penalty makes the inflows the equivalent of risk-less inflows, and therefore a risk-free rate is justified. A table showing the possible coefficient of variation for an inflow and the associated adjustment factor is shown next: Coefficient of Variation 0 0.25 8.26 0.50 0.51 -0.75 0.76 1.00 1.01 1.25 Year 1 Assume a $173,000 project provides the following inflows with the associated coefficients of variation for each year. Coefficient of Variation 0.11 0.24 0.55 0.79 1.04 Adjustment Factor 0.90 Inflow $ 39,600 56,500 79,700 61,700 61,700 Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods. a. Fill in the table below. Note: Do not round intermediate calculations. Round "Adjustment Factor" answers to 2 decimal places and other answers to the nearest whole dollar. 2 3 4 15 0.80 0.70 0.60 e.se Year 1 2 3 Adjustment Factor Adjusted Inflow
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