fm12 26 - might be riskier than first assessed. Also, if...

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Mini Case: 12 - 26 m. 2. Shrieves typically adds or subtracts 3 percentage points to the overall cost of capital to adjust for risk. Should the new furniture line be accepted? Answer: Since the project is judged to have above-average risk, its differential risk-adjusted, or project, cost of capital would be 13 percent. At this discount rate, its NPV would be $60,541, so it would still be acceptable. If it were a low risk project, its cost of capital would be 7 percent, its NPV would be $104,975, and it would be an even more profitable project on a risk-adjusted basis. m. 3. Are there any subjective risk factors that should be considered before the final decision is made? Answer: A numerical analysis such as this one may not capture all of the risk factors inherent in the project. If the project has a potential for bringing on harmful lawsuits, then it
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Unformatted text preview: might be riskier than first assessed. Also, if the projects assets can be redeployed within the firm or can be easily sold, then, as a result of abandonment possibilities, the project may be less risky than the analysis indicates. n. What is a real option? What are some types of real options? Answer: Real options exist when managers can influence the size and risk of a projects cash flows by taking different actions during the projects life in response to changing market conditions. 1. Investment timing options 2. Growth options a. Expansion of existing product line b. New products c. New geographic markets 3. Abandonment options a. Contraction b. Temporary suspension c. Complete abandonment 4. Flexibility options....
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