Following up Problem 16.22, even though we take riskiness into account, there still is difficulty with NPV
Question:
a. Which of these two risky investments would you prefer? Why?
b. Calculate the expected NPV for both projects, using the same 9%interest rate from Problem 16.22. Based on expected NPV, in which project would you invest?
c. After careful assessment, you have concluded that you are risk-averse and that your utility function can be adequately represented by U (Xi) = ln (Xi), where Xi represents cash flow during year i. Calculate the expected net present utility for each project. Net present utility is given by
d. NPU in part c should incorporate your attitude toward risk. Are your NPU calculations in part c consistent with your preferences in part a? What is there about these two projects that is not captured by your utility function? Can you think of any other way to model your preferences?
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Related Book For
Making Hard Decisions with decision tools
ISBN: 978-0538797573
3rd edition
Authors: Robert Clemen, Terence Reilly
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