Accounting rate of return
Internal rate of return
Hurdle rate
Risk free rate
Answer is Right!
Answer is Wrong!
The correct answer is: D. Risk free rate
The certainty equivalent approach is a method of risk analysis that converts uncertain cash flows into certain cash flows by adjusting them for risk. The adjusted cash flows are then discounted at the risk-free rate to obtain the present value of the project.
The risk-free rate is the rate of return that an investor can expect to earn on a risk-free investment, such as a government bond. It is used as the discount rate in the certainty equivalent approach because it is the rate of return that investors would expect to earn if they were not taking on any risk.
The other options are incorrect because they are not the risk-free rate.
- Accounting rate of return is a measure of profitability that is calculated by dividing net income by average investment. It is not a risk-adjusted measure of profitability.
- Internal rate of return is a measure of profitability that is calculated by finding the discount rate that makes the present value of the project’s cash flows equal to zero. It is not a risk-adjusted measure of profitability.
- Hurdle rate is the minimum rate of return that a project must earn in order to be considered acceptable. It is not a risk-adjusted measure of profitability.