The MNO company is considering an investment in one of the two mutually exclusive proposals. Project A which involves an initial outlay of ₹1,50,000 and project B which has an outlay of ₹1,30,000. The certainty equivalen

CS Professional · Financial, Treasury and Forex Management · PYQS · June 2021
The MNO company is considering an investment in one of the two mutually exclusive proposals. Project A which involves an initial outlay of ₹1,50,000 and project B which has an outlay of ₹1,30,000. The certainty equivalent approach is employed in evaluating risky investments. The current yield on treasury bills is 5% p.a. and the company uses this as riskless rate. The expected values of net cash flows with their respective certainty equivalents are: Year Project A Project B Net Cash flow (₹ thousand) Certainty equivalent Net Cash flow (₹ thousand) Certainty equivalent 1 90 0.8 90 0.9 2 100 0.7 90 0.8 3 110 0.5 100 0.6 Which project should be acceptable to the company ?

Answer & Explanation:

Determination of NPV of project A Year CFAT (Thousand) CE CFAT x CE (Thousand) PV Factor @ 0.05 Total PV 1 90 0.8 72 0.952 68,544 2 100 0.7 70 0.907 63,490 3 110 0.5 55 0.864 47,520 Total present value 1,79,554 Initial outlay 1,50,000 NPV 29,554 Determination of NPV of project B Year CFAT (Thousand) CE CFAT x CE (Thousand) PV Factor @ 0.05 Total PV 1 90 0.9 81 0.952 77,112 2 90 0.8 72 0.907 65,304 3 100 0.6 60 0.864 51,840 Total present value 1,94,256 Initial outlay 1,30,000 NPV 64,256 The NPV is greater; Project B should be acceptable to the company.

Topics: Capital Budgeting

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