CHAPTER 16: Discussion Questions and Problems
1. Differentiate the following terms/concepts:
a. Payback and NPV
Payback is how long it takes for an investment to return its outlay in cashflows without
b. Holding in-the-money options too long and engaging in frequent
acquisitions
These are both proxies for managerial overconfidence. Overconfident managers, thinking
c. Random treatment and self-selection treatment in Camerer and
Lovallo experiment
d. Risk aversion and overconfidence in debt issuance
These two factors are likely to create conflicting effects when it comes to debt issuance. In
2 | P a g e
2. Investment activity is driven by both rational value-maximization and
behavioral influences on the part of managers. Discuss.
3. In the Camerer and Lovallo experiment, let N=10 and c=2. Specify the
number of entrants that maximizes industry profit. What will this industry
profit be? Specify the number of entrants that minimizes industry profits. What
will this industry profit be? What number of entrants leads to zero industry
profits?
4. In the Camerer and Lovallo experiment, overconfidence leads to excessive
entry into markets. Do you believe that if a prospective entrepreneur read this
research she would be more or less likely to undertake a start-up? Explain.
5. You are a divisional manager. Currently you are a member of a committee
which is considering two product investments proposed by two other divisional
managers, Joe and John. While walking over to the presentations, Joe seems
rather arrogant. He mentions that he golfs with the CEO, is a key player in the
firm, and that you could really learn a lot from him. In thinking over the projects
after the presentations, you find you are really leaning toward John’s proposal
even though the projects are quite similar in terms of estimated cashflows and
risks. How can you explain this?