6. Within-firm risk and beta risk Understanding risks that affect projects and t
ID: 2795897 • Letter: 6
Question
6. 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 divisions 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 believes 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 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 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 high stand-alone risk will be a good proxy for within-firm risk.Explanation / Answer
1) Option b and c
If the firm does not risk adjust its discount rate then it will make poor capital budgeting decisions like risker projects would be accepted and less risky projected would be rejected.
2) High
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