You work in the CFO office of an automobile company. You learned that diversific

Question

You work in the CFO office of an automobile company. You learned that diversification would reduce risk, leading to a lower expected return or discount rate. You think this idea is very important because an expected return or a discount rate is a significant input for NPV calculation. The lower a discount rate is, the more attractive projects would be accepted and carried out. So you run into CFO office and suggest that the company start mining business whose stock returns has a negative correlation with automobile stock returns.

Question

Is your suggestion reasonable? How would CFO respond to you?

Explanation / Answer

NPV is not just discount rate dependent, it is cash flow and their timing dependent also. The projects have to match with the business strategy as well, also the projects have to have good cash flows.

Hence, it would be foolish for automobile company to venture into mining business because it does not gel with the overall strategy of the company. CFO would disimiss the suggestion as being ridiculous.

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