6. Within-firm risk and beta risk Aa Aa Understanding risks that affect projects
ID: 2794620 • Letter: 6
Question
6. Within-firm risk and beta risk Aa Aa Understanding risks that affect projects and the impact of risk consideration Garcia Real Estate is involved in commercial real estate ventures throughout the United States. Some of these ventures are much riskier than other ventures because of market conditions in different regions of the country. If Garcia does not risk-adjust its discount rate for specific ventures properly, which of the following is likely to occur over time? Check all that apply. The firm will become less risky. The firm will reject too many relatively safe projects. The firm will make poor capital budgeting decisions that could jeopardize the long-run viability of the company Generally, a positive correlation exists between a project's returns and the returns on the firm's other assets. If this correlation is ,stand-alone risk will be a good proxy for within-firm risk. high lowExplanation / Answer
a.) If Garcia does not risk-adjust its discount rate for specific ventures properly, it is likely that:
>> The firm will reject too many relatively safe projects
>> The firm will make poor capital budgeting decisions that will jeopardize the long term viability of company.
b.) Generllay, positive coorelation exists between projects returns and return on firms other assets. If the correlation is high, standalone risk will be good proxy for within firm risk.
c.) NPV of each project =$200,000
Std. Dev of Project A =$80,000
Std. Dev of Project B =$120,000
Since, Beta of project A is higher than Project B => Project A has higher market risk than Project B.
The standalone risk of Project-B is higher.
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