12. consistent framing Return to the illustration in Figure 12.2, where the cash flow sequence is -100, 290 and -208. Assume r = 10% is the correct discount rate.

Suppose we take the initial investment of 100 and invest it at r = 10%.

In two periods this will grow to 100(1.10)2 = 121. Alternatively, suppose we invest in this project. In one year we receive 290. Take this amount and invest it for one year. Hence, at t = 2 we have 290(1.10) = 319. Of course, we also must pay out an additional 208 at this point. So we have 319 - 208 = 111. In this way, accepting the project is equivalent to investing 100 now and receiving 111 two periods later; rejecting the project is equivalent to investing 100 now and receiving 121 two periods later. How, then, can the project have internal rates of return of 30% and 60%? What principle of consistent framing is violated here?