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 companys 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.

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

The companys CFO was conducting a sensitivity analysis on the projects financial model.

The companys CFO performed a scenario analysis on the projects financial model.

Evaluating risk is an important part of the capital budgeting process. Which of the following is measured by the variability of the projects expected returns?

Market, or beta, risk

Stand-alone risk

Corporate, or within-firm, risk

When dealing with , diversification is totally ignored.