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BRILLIANT’S Analysis of Risk and Uncertainty in Investment Decisions 479

The above decision tree is divided into two stages, in the first stage, the company has to
decide whether to keep the money in liquid form by depositing it in the bank @15% or to invest the
fund in a machine for production of new product. If the second option is selected, then the company
has to decide whether to buy Machine 1 or Machine 2. 
SOLVED PRACTICAL QUESTIONS

Illustration 5.2.3
Cash Outlays / H¡$e AmCQ>bo (` 10,000)

CFAT Year 1 / df© 1 5,000
Year 2 / df© 2 6,000
Year 3 / df© 3 4,000

Risk free rate of return / [aQ>Z© H$s [añH$ ’«$s aoQ> = 6%
Risk adjusted rate of return for current project 20%, calculate NPV and give your decision.
dV©‘mZ àmoOo³Q> Ho$ {bE [aQ>Z© H$s [añH$ ES>OñQ>oS> aoQ> = 20%, 30%, NPV H¡$볶yboQ> H$ao Ed§ AnZm {S>{gOZ Xod|&
Solution:

 5,000 6,000 4,000 
NPV = ` 10,000 +   2  3  = ` 641
 1.20 (1.20) (1.20) 
Since NPV of above project is positive, therefore project should be accepted.
Illustration 5.2.4

A company uses certainty equivalent approach to evaluate risky investments. It has collected
the following details for a project which is under consideration:
EH$ H§$nZr [añH$s B§doñQ>‘|Q> Ho$ ‘yë¶m§H$Z Ho$ {bE gQ>}ÝQ>r Bp³ddoboÝQ> EàmoM H$m Cn¶moJ H$aVr h¡& BgZo EH$ àmoOo³Q>
Ho$ {bE {ZåZ{b{IV {ddaU EH${ÌV {H$¶o h¢ Omo ZrMo {dMma {H$¶o J¶o h¢…

Years Cash flow Certainty Equivalent
(df©) (H¡$e âbmo) (gQ>}ÝQ>r Bp³ddoboÝQ>)
(`) (`)

0 (–) 2,00,000 1.0
1 1,60,000 0.8
2 1,40,000 0.7
3 1,30,000 0.6
4 1,20,000 0.4
5 80,000 0.3
Cost of capital for the firm is 12%. Should the project be accepted?
g§ñWm Ho$ {bE H¡${nQ>b H$m°ñQ> 12% h¡& ³¶m àmoOo³Q> H$mo ñdrH$ma {H$¶m OmZm Mm{hE?