Attempts: 2 Keep the Highest: 276 4. Certainty equivalent approach Aa Aa B Another procedure by which to evaluate project risk is the certainty equivalent approach. Under this approach, a project's expected future cash flows are adjusted from their forecastedand generally risky-values to their equivalent certain, or guaranteed, values. Thus, each certainty equivalent cash flow represents a risk-free cash flow that the decision-maker considers to be equal to the riskier cash flow. Consider the case of the Green Zebra Media Company: The company has forecasted cash flows expected from a planned investment project. Considering its uncertain economic conditions, the firm's managers want to adjust the project's risk and then estimate its net present value (NPV) using the certainty equivalent factor approach. You've been assigned to complete this analysis. Using the data available to you in the following table, complete the certainty equivalent analysis for the project. Use 6% as the tax-adjusted risk-free rate in your analysis. Remember, the firm's cost of capital reflects the average riskiness of the company, and using the firm's cost of capital in your analysis would lead to a double counting of the project's risk. Green Zebra Media Company: Calculation of Certainty Equivalent Net Present Value Year Certainty Equivalent Present Value of Cash Cash Flow Flows -$26,000 -$26,000 O - N m + Expected NCF -$26,000 $23,400 $20,800 $19,500 $16,900 Certainty Equivalent Factor (a) 1.00 0.85 0.70 0.55 0.40 True or False: The certainty equivalent method can easily accommodate differential risk among cash flows