# NPV

Look back to the cash flows for projects F and G in Section 5 (page 112; also below). The cost of capital was assumed to be 10%. Assume that the forecasted cash flows for projects of this type are overstated by 8% on average. That is, the forecast for each cash flow from each project should be reduced by 8%. But a lazy financial manager, unwilling to take the time to argue with the project's sponsors, instructs them to use a discount rate of 18%.

a. What are the projects' true NPVs?

b. What are the NPVs at the 18% discount rate?

c. Are there any circumstances in which the 18% discount rate would give the correct NPVs? (Hint: Could upward bias be more severe for more-distant cash flows?)

C0 C1 C2 C3 C$ C5

F -9,000 6,000 5,000 4,000 0 0

G -9,000 1,800 1,800 1,800 1,800 1,800

Answers:

A. Formula Calculation TIP: Use POWER function to calculate (1+r)^t

NPV-Project F T C

NPV-Project G T C

B.

NPV-Project F T C

NPV-Project G T C

C.

T

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