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Unformatted text preview: Lecture 12 Lecture 12 NPV Analysis Accounting for Risk NPV Analysis Accounting for Risk More risk requires a higher expected return Corporate investments satisfy a riskreturn separation theorem. The expected return on a project has to compensate shareholder for the systematic risk they are bearing. ( 29 flow cash in inherent risk for premium foregone time for premium r r r R r R k 1 j j j ρ ρ β ∑ = + = + = If the riskless interest rate is r, the required per period expected return over the life of the project must be at least as great as R For CAPM, k=1 and the unanticipated movements in market is the only risk factor. Thus ( 29 r R r R M + = β More risk requires a higher expected return If the risk of different components of cash flow, or different time periods, varies different riskadjusted discount rates could be used. A project with expected cash flows needs a positive risk adjusted expected NPV : ( 29 t C ( 29 ( 29 risk and time for g discountin composite r 1 C C R 1 C C NPV T 1 t t t T 1 t t t ∑ ∑ = = + + + = + + = ρ However if many different discount rates are used, then it is more difficult to explain the basis of the assumptions it is more difficult to examine the effects of varying rates it is more difficult to compare projects The Risk Premium under 100 % Equity Finance...
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This note was uploaded on 12/20/2011 for the course ECON 448 taught by Professor Bejan during the Spring '06 term at Rice.
 Spring '06
 Bejan

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