The model factors in elements of economic and

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: ). The model factors in elements of economic and political risk to obtain the country’s risk premium and develops betas for each country on the basis of the local market’s volatility and its correlation to the U.S. market. For example, the high volatility of Brazil’s market has a low correlation to the U.S. market, so the country beta was .81. With the risk-free rates and country betas, Bestfoods could calculate local and global costs of capital. This more sophisticated approach gave Bestfoods the confidence to pursue an aggressive international strategy that increased shareholder value and resulted in Unilever offering a substantial premium to acquire the company. In this chapter we’ll look at other techniques that companies use to incorporate risk into the capital budgeting process. W 425 426 PART 3 LG1 Long-Term Investment Decisions 10.1 Introduction to Risk in Capital Budgeting The capital budgeting techniques introduced in Chapter 9 were applied in an environment we assumed to be certain. All of the projects’ relevant cash flows, developed using techniques presented in Chapter 8, were assumed to have the same level of risk as the firm. In other words, all mutually exclusive projects were equally risky, and the acceptance of any project would not change the firm’s overall risk. In actuality, these situations are rare—project cash flows typically have different levels of risk, and the acceptance of a project generally does affect the firm’s overall risk, though often in a minor way. We begin this chapter by relaxing the assumptions of a certain environment and equal-risk projects, in order to focus on the incorporation of risk into the capital budgeting decision process. For convenience, in this chapter, we continue the Bennett Company example that was used in Chapter 9. The relevant cash flows and NPVs for Bennett Company’s two mutually exclusive projects—A and B—are summarized in Table 10.1. In the following three sections, we use the basic risk concepts presented in Chapter 5 to demonstrate behavioral approaches for dealing with risk, international risk considerations, and the use of risk-adjusted discount rates to explicitly recognize risk in the analysis of...
View Full Document

This document was uploaded on 01/19/2014.

Ask a homework question - tutors are online