Your company is very well-diversified, producing and selling all kinds of goods

Question

Your company is very well-diversified, producing and selling all kinds of goods and services, with each division being approximately of the same value/size. The beta of your company is therefore effectively 1.00. The market risk premium (the average/expected difference between the market return and the risk-free rate) is 7.75% and the return on a long-term government bond is 3.75%. You have discovered an exciting opportunity to create a new medicine that will cure the common cold. This project will require a $1 billion investment, spread out equally between now (t = 0) and the end of this year (t = 1), and will produce $145 million dollars in perpetuity starting in year 2 (t = 2). Should you propose this investment to your CEO?

Which of the following asnswers is correct?

a)Yes.

b)It can't be decided until the systematic risk of the project can be quantified.

c)It can't be decided even if the systematic risk of the project can be quantified.

d)No.

Explanation / Answer

It can't be decided until the systematic risk of the project can be quantified.

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