ACCA Financial Management (F9) Certification Practice Exam

What is a method to reduce estimated cash inflows to a very safe level?

1. Payback period

2. Certainty-equivalent method

3. Sensitivity analysis

4. Scenario building

The correct answer is: Certainty-equivalent method

The certainty-equivalent method is an approach used to assess the risk associated with cash inflows by adjusting the expected future cash flows to reflect a more conservative or ‘safe’ level of estimated cash inflows. This technique involves determining a certainty equivalent for each expected cash inflow, which essentially translates uncertain cash inflows into certain values, reflecting the degree of risk associated with those inflows. By converting uncertain cash flows into a certain equivalent, this method effectively mitigates the impact of risk and uncertainty, allowing decision-makers to work with a more cautious and solid estimation of cash inflows. This adjustment ensures that the calculations consider the potential variability in outcomes, leading to a more prudent financial assessment. In contrast, the other options focus on different aspects of cash flow assessment or risk management. The payback period analyzes how quickly an investment can return its initial cost but does not provide a way to adjust estimates for risk. Sensitivity analysis evaluates how changes in key variables impact cash flows but does not inherently adjust inflows to a conservative level. Scenario building allows for the exploration of multiple potential outcomes but does not convert uncertain inflows into cautious estimates. The certainty-equivalent method stands out as the most effective technique for reducing cash inflow estimates to ensure a safe level for