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Certainty-Equivalent Approach

The certainty-equivalent approach (CEA), as an alternative to the risk-adjusted rate method, overcomes some of the weaknesses of the latter method. Under the former approach, the riskiness the project is taken into consideration by adjusting the expected cash flows and not the discount rate. This method eliminates the problem arising out of the inclusion of risk premium in the discounting process.

Steps Involved

The incorporation of risk in the investment decision on the basis of the certainty equivalent approach involves the following steps.

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