One can determine the present value of risky cash flows by estimating
I.the expected cash flows and then discount these at a rate that is consistent with the risk of the cash flows;
II.the certainty-equivalent cash flows and then discount these at the risk-free rate;
III.the expected cash flows and then discount these at the risk-free rate
A)I only
B)II only
C)I and II only
D)III only

Question

Quizplus · Accepted Answer

The present value of risky cash flows can be determined by either estimating the expected cash flows and discounting them at a rate that reflects their risk (I), or by adjusting the cash flows to certainty-equivalent cash flows and discounting at the risk-free rate (II). Discounting expected cash flows at the risk-free rate (III) does not account for risk appropriately.

One Can Determine the Present Value of Risky Cash Flows