Chapter 13 introduces risk as a capital budgeting factor. As we build on capital budgeting from...

Chapter 13 introduces risk as a capital budgeting factor. As we build on capital budgeting from chapter 12, why is it absolutely necessary to introduce and use risk in our project/investment analysis? Why not just use the weighted average cost of capital as we did in chapter 12? Last, how does the introduction of risk potentially change our decision about a project/investment?

Expert Solution

It is important to introduce the the risk in our project and Investment analysis because risk will be always trying to impact the overall cash flows associated with the project and it will also impact the present value of various project so it is better to discount the cash flows in order to to provide with the risk so we will be trying to calculate the risk adjusted return in order to provide with a better estimation of the performance of various project.

we are not using the weighted average cost of capital because it is not including the risk adjustment return so introduction of risk potentially changes our estimation of acceptability and rejection of a project because it will be impacting the cash flows and the rate of discounting to a large extent and it will also impact our acceptance and rejection criteria

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