5. Risk analysis in capital budgeting Projects differ in risk, and risk analysis is a critical component of the capital budgeting process. Consider the case of United Recycling Inc.: United Recycling Inc. is one of the largest recyclers of glass and paper products in the United States. The company is looking into expanding into the cardboard recycling business. The company’s CFO has performed a detailed analysis of the proposed expansion. The selling price of recycled cardboard can fluctuate dramatically, depending on the market conditions. By creating models that used different assumptions for the selling price of recycled cardboard but keeping all other inputs in the model the same, the CFO demonstrated the effect of fluctuations in the price of recycled cardboard. A. Based on the information given, determine which of the statements is correct. The company’s CFO performed a scenario analysis on the project’s financial model. The company’s CFO was conducting a sensitivity analysis on the project’s financial model. B. Evaluating risk is an important part of the capital budgeting process. Which of the following is measured by its effect on the firm’s beta coefficient? Stand-alone risk Market, or beta, risk Risk-adjusted cost of capital Corporate, or within-firm, risk C. When dealing with , diversification is totally ignored.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter11: Capital Budgeting And Risk

Section: Chapter Questions

Problem 5P

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5. Risk analysis in capital budgeting

Projects differ in risk, and risk analysis is a critical component of the capital budgeting process.

Consider the case of United Recycling Inc.:

United Recycling Inc. is one of the largest recyclers of glass and paper products in the United States. The company is looking into expanding into the cardboard recycling business. The company’s CFO has performed a detailed analysis of the proposed expansion.

The selling price of recycled cardboard can fluctuate dramatically, depending on the market conditions. By creating models that used different assumptions for the selling price of recycled cardboard but keeping all other inputs in the model the same, the CFO demonstrated the effect of fluctuations in the price of recycled cardboard.

A. Based on the information given, determine which of the statements is correct.

The company’s CFO performed a scenario analysis on the project’s financial model.

The company’s CFO was conducting a sensitivity analysis on the project’s financial model.

B. Evaluating risk is an important part of the capital budgeting process. Which of the following is measured by its effect on the firm’s beta coefficient?

Stand-alone risk

Market, or beta, risk

Risk-adjusted cost of capital

Corporate, or within-firm, risk

C. When dealing with , diversification is totally ignored.

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