hich of the following statements is CORRECT? The firm\'s corporate, or overall,

Question

hich of the following statements is CORRECT?

The firm's corporate, or overall, WACC should be used to discount all projects' cash flows to find project NPVs. Then, depending on how risky different projects are judged to be, the calculated NPVs should be scaled up or down to adjust for differential risk.

Differential project risk can be accounted for by using "risk adjusted discount rates" or "certainty equivalent cash flows." The certainty equivalent procedure is the one that is used by most firms in the real world.

Other things held constant, if returns on a project are thought to be highly positively correlated with the returns of other firms in the economy, then the project's NPV should be found using a lower discount than would be appropriate if the project's returns were not highly correlated.

Monte Carlo simulation uses a computer to generate random sets of inputs for use in determining projects' NPV. Sensitivity and scenario analysis, on the other hand, requires information on probability distributions and correlations among the independent variables. This makes it easier to get accurate results using simulation than with the other methods, provided adequate computer resources are available.

The assets employed in some projects make better collateral to support debt financing, hence those projects can be financed with a higher debt ratio than other projects. This differential debt capacity, if it results in significantly different WACCs, should be reflected in a capital budgeting analysis.

Explanation / Answer

Hi,

Option B is the correct answer.

Thanks.

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