The firm's cost of equity capital is not used in calculating certainty equivalent NPV.
A risk-adjusted discount rate is not used in calculating certainty equivalent NPV.
The firm's cost of capital is not used in calculating certainty equivalent NPV.
The goal of the certainty equivalent approach is to find the smallest cash flow in each period that would be acceptable in place of that period's risky cash flow, if that smaller cash flow can be depended upon absolutely. The certainty equivalent approach adjusts risky after-tax cash flows to a level judged by the decision-maker to be certain of attainment, by estimating the minimum cash flow for each year of the project. Then the certainty equivalent cash flows are discounted at the risk-free rate of interest to calculate a Certainty Equivalent NPV. The Certainty Equivalent NPV is then compared with the NPV of the project when its risky cash flows are discounted at the company's required rate of return. If the two NPVs are equivalent, the decision-maker will be indifferent between them and will accept the certain cash flow in place of the risky cash flow.
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