You are contemplating an investment project that has two phases. As currently planned, the first phase of
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Question:
a. Using an expected payoff criterion, and discounting at 10 percent, which of the alternatives (First, Both, or Neither) is the optimal decision?
b. What is the breakeven discount rate at which Neither is a better decision than First?
c. Suppose you have access to an additional, similar investment that resembles the original but is more volatile: for the same initial investment, it delivers a Phase I return of 40 percent (that is, either $140,000 or $60,000) with equal probabilities. Similarly, it delivers a Phase II return of 40 percent of the Phase I payouts, again with equal probabilities. Show that this new investment is preferable to the original, with a discount rate of 10 percent.
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