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 companys CFO hired a third-party consulting firm to estimate the cost per ton of processing the cardboard. The consulting firms cost estimate for processing the cardboard was significantly higher than what the CFO had been using in his financial model.

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

A.When the CFO adjusts the cost per ton of processing the cardboard, the projects NPV will decrease.

B.When the CFO adjusts the cost per ton of processing the cardboard, the projects NPV will increase.

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?

1.Stand-alone risk

2.Market, or beta, risk

3.Corporate, or within-firm, risk

When dealing with ______ , diversification is totally ignored.