1. Diversifiable risk Many investment projects are exposed to diversifiable risks. What does “diversifiable” mean in this context? How should diversifiable risks be accounted for in project valuation? Should they be ignored completely?
2. Fudge factors John Barleycorn estimates his firm’s after-tax WACC at only 8%. Nevertheless, he sets a 15% companywide discount rate to offset the optimistic biases of project sponsors and to impose “discipline” on the capital budgeting process. Suppose Mr. Barleycorn is correct about the project sponsors, who are, in fact, optimistic by 7% on average. Explain why the increase in the discount rate from 8% to 15% will not offset the bias.