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    Importance of Accurate Estimate and Discount Rates

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    How accurate do you think a company's estimates of the net present value of a proposed project are under the following scenarios? Are there any important differences in the accuracy to be expected in the various scenarios?

    a) Buying new equipment for a factory line at Ford.
    b) Putting a value on a patent for a new drug at Pfizer.
    c) Buying a new 747 for a NYC-Tokyo route at Japan Air Lines.
    d) Building a store to sell a new product by a startup company

    Discount rates will vary based upon your own personal level of risk tolerance. For example, I might be willing to buy a risky stock if I think I'll earn 10% while my wife would need at least 20% before she'd consider it. What's your discount rate for the following types of equities? How did you determine that rate?
    a) A risk free equity (a US Treasury Note - called risk free because if they can't pay, your money is worthless!)
    b) A CD at a South American bank paying in their local currency.
    c) A stock in a company that has a secure stream of income from a long term contract customer.
    d) A stock in a company that has an interesting business plan but no real operations as of yet (as NY Lotto says "A Dollar and A Dream")

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    https://brainmass.com/business/net-present-value/importance-of-accurate-estimate-and-discount-rates-102746

    Solution Preview

    How accurate do you think a company's estimates of the net present value of a proposed project are under the following scenarios? Are there any important differences in the accuracy to be expected in the various scenarios?

    We know that the estimates of NPV depend on the initial investment (cost of the project), the future cash inflow (or saving in cost) and required return rate. Since the return rate is already estimated before the investment, it does not vary in the following cases.

    a) Buying new equipment for a factory line at Ford.
    The initial investment is clearly the price of the factory line (assuming the price is paid at present). The future cash flow comes from the saving in labour costs and expenses. Since the labour expenses can be easily calculated by summing their salaries and fringe benefits, the estimate of the NPV is highly accurate.

    b) Putting a value on a patent for a new drug at Pfizer.
    The development expense is only a ...

    Solution Summary

    683 words on the differences in accuracy in scenarios from Ford buying equipment to drug patents as well as a question on discount rates answered.

    $2.19

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