Economics of risk and uncertainty

Apr 22nd, 2015
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Question one: (a) Net Present Value = Summation of [(Net cash inflow at period t)/ (Opportunity cost)] = Cashflows/ (1 + r) t = 7Million/ (1+ 0.08)1 + 7Million/ (1 + 0.08)2 Therefore, NPV = $12,482,853.223 The alternative that is preferred is thus the option where the money is provided in two equal installments of seven million. Reason behind the decision; There is more economic benefit in the case of two equal installments of seven million which has a higher net present value of $482,853.223, above the one that is provided in lumpsome.

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Question one:(a)Net Present Value = Summation of [(Net cash inflow at period t)/ (Opportunity cost)]= Cashflows/ (1 + r) t= 7Million/ (1+ 0.08)1 + 7Million/ (1 + 0.08)2Therefore, NPV = $12,482,853.223The alternative that is preferred is thus the option where the money is provided in two equal installments of seven million.Reason behind the decision; There is more economic benefit in the case of two equal installments of seven million which has a higher net present value of $482,853.223, above the one that is provided in lumpsome.(b)Suppose the interest rate changed to 12%Net Present Value = Summation of [(Net cash inflow at period t)/ (Opportunity cost)]= Cashflows/ (1 + r) t= 7Million/ (1+ 0.12)1 + 7Million/ (1 + 0.12)2Therefore, NPV = $11,830,357.143In this case, the payment of the money in lumpsome would be preferred to payment in the two equal installments since it yields more Net present value of the money.(c)A possible scenario where this case applies in real life;The following decision making approach is used in determining the most suitable investment decisions in business and projects by various individuals and institutions.Under this approach therefore, the projects which have the largest value of Net Present Value are preferred over those which have less since this means greater economic returns.Question Two;(a)Project A's Expected Net Present ValueYear 0Year 1Year 2Year 3ProbabilityCashflowsExpected CashflowsProbabilityCashflow

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