Question
1. Project A and B are both available to BetaGo. The initial costs are C0A = 100 and C0B = 300 for A and B,
1. Project A and B are both available to BetaGo. The initial costs are C0A = 100 and C0B = 300 for A and B, respectively. Project A alone will generate a cash flow C2A = 242 at t2, and project B alone will generate a cash flow C2B = 484 at t2. But A and B are not independent. Indeed, if BetaGo invests in both A and B, it can receive an extra 121 cash flow (the positive externality) at t2. The rate of return is 10%. (a) If BetaGo can invest in either A or B, which one will BetaGo choose? [Hint: if the NPVs of these two projects are same, BetaGo will choose either one.] (b) If BetaGo can invest in both A and B, will BetaGo invest in both projects? Suppose that the manager of BetaGo has limited attention. Hence, if she invests in A and B at the same time, she cannot do a good job. In particular, if she invests in both A and B at t0, C2A becomes 181.5, and C2B becomes 363. (The positive externality will still be generated.) (c) What is the optimal project choices now?
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