In theory, the risk-free rate is more appropriate for the NPV calculation in the certainty equivalent approach since:
A)it is assumed that there is no business-specific risk associated with the projects.
B)certainty equivalent factors cannot take negative values.
C)certainty equivalents imply zero risk.
D)certainty equivalents consider unsystematic risk only.

Question

Quizplus · Accepted Answer

Certainty equivalents imply zero risk, which aligns with the concept of a risk-free rate. The certainty equivalent approach adjusts the project's cash flows to reflect their certainty equivalent value, essentially removing the risk. Therefore, using a risk-free rate, which assumes no risk, is appropriate for discounting these adjusted cash flows.

In Theory, the Risk-Free Rate Is More Appropriate for the NPV