Problem:
For Ejection Air Seats Airlines new project, the initial outlay required is $22 million. Net cash flows over the 4-year life cycle and the corresponding certainty-equivalents of the new model are as follows:
|
Year
|
Net Cash Flow
|
Certainty-equivalent
|
|
1
|
$15 million
|
0.90
|
|
2
|
13 million
|
0.75
|
|
3
|
11 million
|
0.55
|
|
4
|
9 million
|
0.30
|
Required:
The firm's cost of capital is 14% and the risk-free rate is 6%. Bull uses the certainty-equivalent approach in evaluating above-average risk investments such as this one. What is the project's certainty-equivalent NPV? Explain your answer and provide examples.