Understanding risks that affect projects and the impact of risk consideration WS
ID: 2786840 • Letter: U
Question
Understanding risks that affect projects and the impact of risk consideration WSP Inc. Is involved in a wide range of unrelated projects. The company will pursue any project that it thinks will create value for its stockholders. Consequently, the risk level of the company's projects tends to vary a great deal from project to project ir wsp Inc. does not risk-adjust its discount rate for specific projects properly, which of the following is likely to occur over time? Check all that apply. The firm will increase in value. The firm's overall risk level will increase. The firm could potentially reject projects that provide a higher rate of return than the company should require. How do managers typically deal with within-firm risk and beta risk when they are evaluating a potential project? O Subjectively O Quantitatively Consider the case of another company. Davis Printing is evaluating two mutually exclusive projects. They both require a $1 million investment today and have expected NPVs of $200,000. Management conducted a full risk analysis of these two projects, and the results are shown below. Risk Measure Standard deviation of project's expected NPVs Project beta Correlation coefficient of project cash flows (relative to the firm's existing projects) 0.7 Project A Project B $80,000 $40,000 0.9 1.1 0.9 Which of the following statements about these projects' risk is correct? Check all that apply. Project B has more stand-alone risk than Project A. Project B has more market risk than Project A. Project A has more market risk than Project B. Project B has more corporate risk than Project A.Explanation / Answer
1. When the firm does not risk adjust the discount rates then over a period of time it may eventually reject projects that do have a higher rate of return.
2. With in firm risk and beta risk are dealt quantitatively by incorporating in the formulae for calculation of project specific risk.
3. higher project beta means company is either using more of debt than equity and hence the earnings or cashflow from that particular project are less viable.
Correlation coefficient with existing cashflows shows that if the existing cashflows increased the ptojeCt's cashflows are also favourably impacted.
Hence project B is having more stand alone risk than A.
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