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 used sophisticated software to analyze a large number of scenarios and generate estimated rates of return and risk indexes.

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

The companys CFO conducted a sensitivity analysis to evaluate the projects financial model.

The companys CFO used a Monte Carlo simulation to evaluate the projects financial model.

Evaluating risk is an important part of the capital budgeting process. Which of the following is measured by its effect on the firms beta coefficient?

Corporate, or within-firm, risk

Market, or beta, risk

Risk-adjusted cost of capital

Stand-alone risk

The problem with using __________ when trying to adjust for projects that are more risky or less risky than a firms average project is that these adjustments are extremely subjective and difficult to justify