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A UK based company is considering an investment of GB£1,00,0000 in a project in the USA it is
anticipated that the following cash flows will arise from this project.
The cash flows will be either USD 4,00,000 with a probability of 40% or USD 7,00,000 with a
with a probability of 60% for each of the next three years remitted to the UK at the end of each year
GB £5,54,047
GB £2,87,639
GB £3,91,640
GB £ (1,11,973)
The CEO of HJ wishes to evaluate an investment using the certainty equivalent basis. The project involves
an initial outflow of D$2m, There will be a single inflow in exactly one year after which the project will be
concluded.
The CEO believes that the expected value of the inflow from this project is D$5m. He believe that the most
likely inflow will be D$4.2m. He would be prepared to accept a guranteed sum of D$3.5m as an alternative
The cost of capital for this project is 8% and the risk-free rate is 3%. The one year discount factors for
those rates are 0.926 and 0.971 respectively
What is the net present value of this project on the certainly equivalent basis ?
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