Look back to the cash flows for projects F and G in Section 5-3.

The cost of capital was assumed to be 10%. Assume that the forecasted cash flows for projects of this type are over- stated by 8% on average. That is, the forecast for each cash flow from each project should be reduced by 8%. But a lazy financial manager, unwilling to take the time to argue with the projects sponsors, instructs them to use a discount rate of 18%. a. What are the projects true NPVs? b. What are the NPVs at the 18% discount rate. c. Are there any circumstances in which the 18% discount rate would give the correct NPVs? (Hint: Could upward bias be more severe for more-distant cash flows?)

FLOWS $ C4 Project C1 C5 IRR% NPV AT 10% CASH C2 C3 +5000 | +4000 +1800 +1800 0 0 ... 33 3592 -9000 -9000 +6000 +1800 +1800 +1800 20 9000