WSP Inc. is involved in a wide range of unrelated projects. The company will pursue any project that it thinks will create value for its stockholders. Consequently, the risk level of the company’s projects tends to vary a great deal from project to project.
If WSP Inc. 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 increase in value.
The firm could potentially reject projects that provide a higher rate of return than the company should require.
The firm’s overall risk level will increase.
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.
Consider the case of another company:
Davis Printing is evaluating two mutually exclusive projects. They both require a $1 million investment today and have expected NPVs of $200,000. 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||$80,000||$40,000|
|Correlation coefficient of project cash flows (relative to the firm’s existing projects)||0.7||0.5|
Which of the following statements about these projects’ risk is correct? Check all that apply.
1.Project A has more stand-alone risk than Project B.
2.Project A has more corporate risk than Project B.
3.Project A has more market risk than Project B.
4.Project B has more corporate risk than Project A.