A market where prices reflect all information that

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A market where prices reflect all information that could be used to determine true value of assets Market anomalies and behavioral finance The dot-com bubble of the nineties led many to believe that investors are not 100% rational all the time. Behavioural psychology has led to the development of behavioural finance. Attitude Toward Risk : When making risky decisions, people are particularly loath to incur losses, even if those losses are small. Beliefs About Probabilities : Investors are often tempted to project recent success into the future, but forget about the losses from distant past. They tend to be overconfident. Biases in decision making Prior hypothesis bias: Prior beliefs dominate even when evidence is otherwise Representativeness Bias: Incorrect generalizing from small sample/incident Illusion of Control: Overconfidence decision-maker can control events Escalating commitment: Sunk-cost commitment in face on contrary evidence Improving decision making Uncover biases and manage time wisely Adopt a sustainability strategy Become a learning organization Promote individual creativity Finance Lecture 6 (Chapter 9) A simple investment decision… TTC tokens cost $1.80 (student volume discount). I need 2 tokens to commute school, 5 days a week ($1.80 x 2 x 5 = $18/week) Or can I buy a bike ($180) and ride to school In how many weeks will the bike have “paid for itself” Payback criteria Payback is the time period it takes for the cash flows generated by the project to cover the initial investment in the project. If the payback period is less than a specified cutoff point, the project is a go. Example: A company has the following three investment opportunities. The company accepts all projects with a 2 year or less payback period and uses a 10% discount rate. Discounted Payback criteria
Discounted payback is the time period it takes for the discounted cash flows generated by the project to cover the initial investment in the project. The acceptance rule is still the same – the discounted payback should be less than a pre-set cutoff point. Although better than payback, it still ignores all cash flows after an arbitrary cutoff date. Therefore, it will reject some positive NPV projects. A firm is considering the following projects. Its opportunity cost of capital is 10% A) what are the payback and discounted payback periods for each project? B) if we use the payback rule with a cut-off period of 2 years, which projects do we accept? C) if we use the payback rule with a cut-off period of 3 years, which projects do we accept? Choosing between mutually exclusive projects

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