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Within-firm risk and beta risk

Understanding risks that affect projects and the impact of risk consideration

Yatta Net International has manufacturing, distribution, retail, and consulting divisions, Projects undertaken by the manufacturing and distribution divisions tend to be low-risk projects, because these divinions are well established and have predictable demand. The company started its retail and consulting divisions within the last year, and it is unknown if these divisions will be profitable. The company knew that opening these new divisions would be risky, but its management beloves the divisions have the potential to be extremely profitable under favorable market conditions. The company is currently using its WACC to evaluate new projects for all divisions.
If Yatta Net International does not rink adjust es discount rate for specfic projects property, which of the following is likely to occur over time? Check all that apply.
– The firm will reject too many relatively safe projects.
– The firm will become less risky.
– The firm will make poor capital budgeting decisions that could jeopardize the long-run viability of the company.
When a project involves an entirely new product line, the firm may be able to obtain betas from ________ to calculate a weighted average cost of capital (WACC) for its new product line.


Consider the case of another company. Davis Printing is evaluating two mutually exclusive projects. They both requre a $5 milion investment today and have expected NPVS of $1,000,000. Management conducted a full risk analysis of these two projects, and the results are shown below


Risk Measure —–Project A,Project B
Standard deviation of project’s expected NPVS Project — $400,000,
$200,000

Project beta = 0.9, 1.1

Correlation coefficient of project cash flows (relative to the firm’s existing projects) = 0.7, 0.5

Which of the following statements about these projects’ risk is correct? Check all that apply

– Project A has more market risk than Project B.
– Project B has more stand-alone risk than Project A.
– Project B has more corporate risk than Project A
– Project A has more corporate risk than Project B
 
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