Q1. Present Value and Future Value
Sample Example: Chapter 1 Question 1.a
Given an opportunity discount rate (ODR) of 14%, the present value of the $11.5m alternative is $9.86m. The $2.5m immediately received is not discounted. Next year, the $4m is discounted by the factor 1/(1.14), or 0.87719. In the second year, the $5m is discounted by the factor 1/(1.142), or 0.76946. The present value calculation is:
PV ($11.5m) = $2.5m + $4m/(1.14) + $5m/(1.142)
= $2.5m + $3.51m + $3.85m = $9.86m
Thus, the president is not maximizing the value of the foundation scholarships under the accepted alternative.
Q2. The Coefficient-of-Variation (CV) Decision Criterion
Sample Example: Chapter 2 Question 1
a. The CV of the T-shirt project is (1,000/3,000) = 0.33, and the CV of the umbrella project is (2,000/4,000) = 0.5. Using this method of risk adjustment, the T-shirt project is preferred.
b. Under the maximin criterion, the worst outcome of the T-shirt project is $500 in profit, while the worst outcome of the umbrella project is a loss of $1,000. Comparing these minimums, the T-shirt project is preferred.
c. The certainty equivalent of these two projects depends on the student’s self-evaluation of their attitude toward risk. The aim is to consider how much reduction in value the student would accept if the risk of the project in question was reduced to zero.