Question

Yatta Net International has manufacturing, distribution, retail, and consulting divisions. Projects undertaken by the manufacturing and distribution divisions tend to be low-risk projects, because these divisions are well established and have predictable demand. The company started its retail and consulting divisions within the last year, and it is unknown if these divisions will be profitable. The company knew that opening these new divisions would be risky, but its management believes the divisions have the potential to be extremely profitable under favorable market conditions. The company is currently using its WACC to evaluate new projects for all divisions.

If Yatta Net International does not risk-adjust its discount rate for specific projects properly, which of the following is likely to occur over time? Select all that apply.

A.) The firm will accept too many relatively risky projects.

B.) The firm will accept too many relatively safe projects.

C.) The firm will become less valuable.

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.) Low

B.) High

Consider the case of another company. Turnkey 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	$120,000
Project beta	0.9	1.1
Correlation coefficient of project cash flows (relative to the firm’s existing projects)	0.6	0.4

Which of the following statements about these projects’ risk is correct? Select all that apply.

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

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

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

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

Answer 1

QUESTION 1)If Yatta Net International does not risk-adjust its discount rate for specific projects properly, which of the following is likely to occur over time?

Solution : OPtion A and Option C

Explanation : Wacc is the minimum required rate for the company which applies to all projects When RADR is used, discount rate is marked upwards for risky pprojects. all normal projects are discounted at WACC. SO if discount rate is not adjusted upwards, even risky projects will generate positive NPVs and may be selected. So the firm will accept relatively risky projects. In such cases, value of the firm may decrease in the long term

Question 2) a positive correlation exists between a project’s returns and the returns on the firm’s other assets. If this correlation is___HIGH_________ , stand-alone risk will be a good proxy for within-firm risk.

Solution : Option b High

Explanation : Managers find it difficult to claculate within firm risk and Beta risk, they generally consider it subjectively. so when positive corre;ation is there , it can be used easily by them

Question 3)

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	$120,000
Project beta	0.9	1.1
Correlation coefficient of project cash flows (relative to the firm’s existing projects)	0.6	0.4

Solution : OPtion A and Option B

Explanation :

Project's beta is a measure of systematic or market risk present in a particular project. It is used to adjust for differences between project's risk and firm's average risk. So Beta of B is higher which mean it has more market risk

When Co-relation co-eeficient betwen the project and other projects of the firm is high, its standalone risk is high