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
Chapter15: Capital Structure Decisions
Section: Chapter Questions
Problem 12SP
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Vaibhav
![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](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F245f0205-cf64-4e7b-b7c8-eb5e5da979b8%2Fba0a843a-de11-4f88-9978-e2cc53c3ae34%2Fcysaq8_processed.jpeg&w=3840&q=75)
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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