Question

4. Within-firm risk and beta risk

Understanding risks that affect projects and the impact of risk consideration

Garcia Real Estate is involved in commercial real estate ventures throughout the United States. Some of these ventures are much riskier than other ventures because of market conditions in different regions of the country.

If Garcia does not risk-adjust its discount rate for specific ventures properly, which of the following is likely to occur over time? Check all that apply.

a) The firm will increase in value.

b) The firm’s overall risk level will increase.

c) The firm could potentially reject projects that provide a higher rate of return than the company should require.

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.

a)high b)low

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
Project beta	0.9	1.1
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.

a) Project B has more market risk than Project A.

b) Project A has more corporate risk than Project B.

c) Project A has more stand-alone risk than Project B.

d) Project B has more corporate risk than Project A.

Answer 1