Question

Capital budgeting decisions are risky.:

• Research the risks associated with capital budgeting and identify the three that you believe are the most significant risks.
• Describe these risks and support your assertion with specific reasons.

Answer 1

CAPITAL BUDGETING

DEFINITION: Capital budgeting is the process a business undertakes to evaluate potential major projects or investments.

Construction of a new plant or a big investment in an outside venture are examples of projects that would require capital budgeting before they are approved or rejected.

RISKS ASSOCIATED WITH CAPITAL BUDGETING:  

projects differ in risks and it should be reflected in capital budgeting decisions .

However,it is difficult to measure risk,especially new projects without a history.

Three separate and distinct type of risks involved are

1.STAND ALONE RISK :

the risk an asset would have if it was a firm only asset and if investors owned only one stock.it is measured by the variability of asset expected return.

2. CORPORATE RISK :

risk considering the firms diversification but not stake holder diversification .It is measured by the projects effect on uncertainty about the firm future expected returns.

3. market risk :

considers both firm and stack holder diversification .it is measured by the project beta coefficient.