The certainty equivalent approach is a risk evaluation technique. Which of the following statements is (are) correct?
I. Certainty equivalents adjust the cash flows in the numerator of the NPV equation.
II. Using the RADR involves adjustments to the denominator of the NPV equation.
A) Only statement I is correct.
B) Only statement II is correct.
C) Both statements I and II are correct.
D) Neither statement I nor II is correct.

Question

The certainty equivalent approach is a risk evaluation technique. Which of the following statements is (are) correct?
 I. Certainty equivalents adjust the cash flows in the numerator of the NPV equation.
II. Using the RADR involves adjustments to the denominator of the NPV equation.
A) Only statement I is correct.
B) Only statement II is correct.
C) Both statements I and II are correct.
D) Neither statement I nor II is correct.

Quizplus · Accepted Answer

Both statements are correct. The certainty equivalent approach adjusts the cash flows (numerator) to reflect risk, while the Risk-Adjusted Discount Rate (RADR) modifies the discount rate (denominator) to account for risk in the NPV calculation.

The Certainty Equivalent Approach Is a Risk Evaluation Technique