Refer to the discussion of the automobiles in the section on "TradingOff Conflicting Objectives: The Basics." We discussed switching first from the Standard to the Norushi, and then from the Norushi to the Portalo. Would it make sense to consider a direct switch from the Standard to the Portalo? Why or why not?

where the summation is over all future cash flows including the current x0.
a. Explain how the NPV criterion is similar to the additive utility function that was discussed in this chapter. What are the attributes? What are the weights? Describe the way cash at time period i is traded off against cash at time period i + 1.
b. Suppose that you can invest in one of two different projects. Each costs $20,000. The first project is riskless and will pay you$10,000 each year for the next 3 years. The second one is risky. There is a 50% chance that it will pay $15,000 each year for the next 3 years and a 50% chance that it will pay only $5,000 per year for the next 3 years. Your discount rate is 9%. Calculate the NPV for both the riskless and risky projects. Compare them. What can you conclude about the use of NPV for deciding among risky projects?
c. How might your NPV analysis in part b be modified to take risk into account? Could you use a utility function? How does the idea of a risk-adjusted discount rate fit into the picture? How could the interest rate be adjusted to account for risk? Would this be the same as using a utility function for money?

Transcribed Image Text:

NPV=홈 (1 + r )