### 6. Within-firm risk and beta risk#### Understanding risks that affect projects and the impact of risk considerationYatta 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 accept too many relatively safe projects.- [ ] The firm will accept too many relatively risky projects.- [ ] The firm will become less valuable.#### How do managers typically deal with within-firm risk and beta risk when they are evaluating a potential project?- [ ] Subjectively- [ ] Quantitatively **Risk Analysis of Mutually Exclusive Projects**Consider the case of another company, Kim Printing, which is evaluating two mutually exclusive projects. Both projects require a $3 million investment today and have expected Net Present Values (NPVs) of $600,000. Management conducted a full risk analysis of these two projects, and the results are shown below.| **Risk Measure** | **Project A** | **Project B** ||--------------------------|--------------|--------------|| **Standard deviation of project’s expected NPVs** | $240,000 | $360,000 || **Project beta** | 0.9 | 0.7 || **Correlation coefficient of project cash flows (relative to the firm’s existing projects)** | 0.7 | 0.9 |**Explanation of Data:**1. **Standard Deviation of Project’s Expected NPVs:** - **Project A:** $240,000 - **Project B:** $360,000 - This measure shows the volatility or risk associated with the project’s expected cash flows. A higher standard deviation indicates higher stand-alone risk.2. **Project Beta:** - **Project A:** 0.9 - **Project B:** 0.7 - Beta measures the project's market risk relative to the market as a whole. A higher beta indicates a higher sensitivity to market movements.3. **Correlation Coefficient of Project Cash Flows (relative to the firm’s existing projects):** - **Project A:** 0.7 - **Project B:** 0.9 - This metric indicates how the project's cash flows correlate with the company's existing projects. A higher correlation means the project's performance is more likely to be influenced by the same factors affecting the firm’s current projects, indicating higher corporate risk.**Quiz:**Which of the following statements about these projects’ risk is correct? **Check all that apply.**- [ ] Project B has more stand-alone risk than Project A.- [ ] Project B has more corporate risk than Project A.- [ ] Project A has more stand-alone risk than Project B.- [ ] Project A has more market risk than Project B.This setup provides a comprehensive understanding and assessment of the risk measures involved in evaluating investment projects, supporting better decision-making.

The likelihood that actual results will differ from expected results is referred to as risk. To…

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 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 accept too many relatively safe projects. The firm will accept too many relatively risky projects. The firm will become less valuable. How do managers typically deal with within-firm risk and beta risk when they are evaluating a potential project? O Subjectively O Quantitatively

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS