7  Investments

In an investment analysis, one starts with a project’s expected cash flows and evaluates the profitability of the project by comparing it with a given alternative. Consider project Alfa where you invest €10 million and receive €2 million at the end of each year for the next three years, and €12 million at the end of the fourth year. This can be formulated in the following way, with the amounts representing millions of euros:

(–10, 2, 2, 2, 12)

Since you invest 10, receive 2 each year and have the entire amount invested returned the last year, the rate of return must be 2/10 = 20 per cent for project Alfa. Whether or not this is a satisfactory return on the investment depends on the project’s risk. Assume that you can receive 8 ...

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