Froeb and mccanns chapter 19 a individual problems 19

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Froeb and McCann’s chapter 19: a. Individual problems: 19-3 “Soft Selling” and Adverse Selection The seller of the product knows whether the product works; the buyer does not (the asymmetric information). The buyer is worried that the seller has an incentive to lie—to tell him that the product will reduce costs regardless of whether they will (the adverse selection). The buyer “signals” the quality of his product by offering to be paid only if it works. A seller who knew his product didn’t work would not offer this kind of contract. 19-5 Hiring Employees Expected value = $50,000 Without adverse selection, you would expect to hire an equal number of each type of employee and your expected value would be $65,000 (E(v) = .25(50,000) + .25(60,000) + .25(70,000) + .25(80,000) = $65,000) But with adverse selection, you will not realize this value. If you initially assume an expected value of $65,000 and therefore offer that as your salary, only the $50,000 and $60,000 employees will accept. This drives your expected value down to $55,000. If you lower your offer to $55,000, only the $50,000 employees will accept. The only reasonable offer you can make is $50,000. Salvatore’s c hapter 15: a. Discussion Questions: 7. ( a ) Only when evaluating mutually exclusive investment projects can the NPV and the IRR methods provide contradictory signals as to which investment project the firm should undertake. For a single or independent project the two methods will always give the same accept/reject investment signal. ( b ) The NPV and IRR methods can provide contradictory investment signals because the
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NPV method implicitly and conservatively assumes that the net cash flows generated by the investment project are reinvested at the firm's cost of capital or risk-adjusted discount rate, while the IRR method implicitly assumes that the net cash flows generated by the investment project are reinvested at the same higher IRR earned on the given project. ( c ) When contradictory signals are provided by the NPV and the IRR methods, the former should be used because the firm cannot assume that it can reinvest the net cash flows from the project at the same higher IRR earned on the project. b. Problems: 8. ( a ) The NPV of each project is obtained by subtracting from the present value of the net cash flows ( PVNCF ) for each project the initial cost of the investment ( C 0).
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