a. For an investment analysis to be consistent with the goal of shareholder wealth maximization, it must meet three criteria.
(1) It should place higher weight on earlier cash flows than on more distant cash flows and it should not weight cash flows arising in different time periods the same.
(2) It should penalize more heavily the expected cash flows of riskier projects. Other things being equal, it should rank riskier projects as being less desirable. Summarize the third criterion.
b. Several factors contribute to the tendency of accepted projects to do less well than expected. Understanding the nature of these biases can help a firm guard against them and reduce the likelihood of accepting a project because of overly optimistic cash flow forecasts.
Examine the project cash flow estimate bias of over-optimism.