A project has the following forecasted cash flows:

Cash Flows, $ Thousands C 0 C 1 C 2 C 3

100 40 60 50 The estimated project beta is 1.5. The market return r m is 16%, and the risk-free rate r f is 7%.

a. Estimate the opportunity cost of capital and the project’s PV (using the same rate to discount each cash flow).

b. What are the certainty-equivalent cash flows in each year?

c. What is the ratio of the certainty-equivalent cash flow to the expected cash flow in each year?

d. Explain why this ratio declines.

AppendixLO1