The following are a project's risky caask flows and certainty
equivalent coefficients.  The project's initial cash outlay is
$110,000 and is known with certainty.  The firms required rate of
return is 10% and the risk free rate is 6%.
year     risky cash flow                 certainty equivalent
coefficients
1            $10,000                         0.095
2             20,000                         0.90
3             40,000                         0.85
4             90,000                         0.75
5             90,000                         0.65

This project's certainty equivalent cash flows in years 1,2,3,4,and 5
respectively are:
a) 9,500 ; 18,000 ; 34,000 ; 67,500 ; 58,500
b) 10,000 ; 9,500 ; 18,000 ; 34,000 ; 67,500
c) 10,000 ; 9,500 ; 18,000 ; 32,000 ; 67,500
d) 58,500 ; 67,500 ; 34,000 ; 18,000 ; 9,500

This projects risk free adjusted NPV is
a)$33,026.56
b)40,710.18
c)21,484.41
d)89,360.33

Hi again k9queen!!!

A risky problem!!!

First of all I think that there is a typo in the certainty equivalent
coefficients (CEQ) for the year 1; it must be 0.95 and not 0.095.

The certainty equivalent cash flows (CECF) for each year are:

CECFi = CFi * CECi

Then

CECF1 = $10,000 * 0.95 = $9,500 ;
CECF2 = $20,000 * 0.90 = $18,000 ; 
CECF3 = $40,000 * 0.85 = $34,000 ;
CECF4 = $90,000 * 0.75 = $67,500 ;
CECF5 = $90,000 * 0.65 = $58,500 .

Then correct answer of the first part of the question is a).


If Rf is the risk free rate, this project´s risk free adjusted NPV is:


             CECFi        
NPV = sum [-----------](i=1 to 5)  -  I      
           (1 + Rf)^i          


    = $9,500 / (1.06)^1 + $18,000 / (1.06)^2 + $34,000 / (1.06)^3 +
     
      + $67,500 / (1.06)^4 + $58,500 / (1.06)^5 - I =
 
    = $8,962.26 + $16,019.94 + $28,547.06 + $53,466.32 + $43,714.60 -
I =

    = $150,710.18 - $110,000 = 

    = $40,710.18

The correct answer is b).

For more information related to this topic, take a look to the
following page at the "Real Option Group" website:
"Certainty-Equivalent Approach"
http://www.rogroup.com/1.2.2.htm


Hope this helps, if you need a clarification, please post a request
for it.
Thank you again for asking to Google Answers.

Best Regards.
livioflores-ga

Yes, you were right-there was a typo! 
Thanks for all the great help!