FIN 645 Session 5 Homework Assignment Answers

Ackert and Deaves: 9-2 Shefrin: 2-5, 3-3

9-2: 2. Consider two investors (A and B) with the following demand curves for a stock:

A: p = 100 - q B: p = 150 2q

a. At a price of $50, how much will A and B purchase? Substituting $50 into the above demand functions gives us q=50 for A and q=50 for B as well.

b. If the price falls to $30, who will increase their holdings more? Explain. Now we redo the exercise for a price of $30. Now q=70 for A and q=60 for B. To go from 50 units, A would have to buy 20 and B would have to buy 10 units.

c. On this basis, which investor seems to more overconfident? In terms of overconfidence, it could be said that A is more overconfident than B.

2-5: Analyst Safa Rashtchys developed his 2010 forecast for eBays revenue by assuming that its annual growth would to about a 30 percent compounded annual growth rate between 2002 and 2010. In the previous year, eBays revenue had grown at the rate

of 62 percent, and the firm forecast that its revenue would increase by 58 percent in 2003. Which, if any, of the behavioral elements described in chapter 1 might have affected Rashtchys long-term forecast? Answer: A strong candidate is bias stemming from anchoring, in that predicting a 30 percent annual growth rate over an 8-year period was anchored on eBays growth rate of 62 percent in 2002 and its growth rate forecast of 58 percent for 2003.

3-3: Consider Robert Galvins approach to evaluating the satellite project proposal. The text suggests that in not developing discounted cash flow analysis, Galvins approach was flawed. In hindsight, Iridium was a failed project for Motorola, and even positive NPV projects can turn out to be failures. Can you provide a critique of the behaviorally-based argument, and suggest some reasons why in foresight it might have been entirely rational for Robert Galvin to have proceeded in the way that he did? Answer: Perhaps time was of the essence, and the economics of the project were so apparent that it made little sense to undertake a cash flow analysis. Or, perhaps there was no meaningful way to construct plausible cash flows in any detailed manner, because the technology was so new. Therefore, any formal analysis would have been little better than Robert Galvins intuitive reaction.

Source: tychousa.umuc.edu