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Unformatted text preview: procedures, along with riskadjustment techniques, should enable the financial manager to make capital budgeting
decisions that are consistent with the firm’s goal of maximizing stock price. CHAPTER 10 Risk and Refinements in Capital Budgeting 451 REVIEW OF LEARNING GOALS
Understand the importance of explicitly recognizing risk in the analysis of capital budgeting
projects. The cash flows associated with capital
budgeting projects typically have different levels of
risk, and the acceptance of a project generally
affects the firm’s overall risk. Thus it is important to
incorporate risk considerations in capital budgeting.
Various behavioral approaches can be used to get a
“feel” for the level of project risk, whereas other
approaches explicitly recognize project risk in the
analysis of capital budgeting projects.
LG1 Discuss breakeven cash inflow, sensitivity and
scenario analysis, and simulation as behavioral
approaches for dealing with risk. Risk in capital
budgeting is the chance that a project will prove unacceptable or, more formally, the degree of variability of cash flows. Finding the breakeven cash inflow
and assessing the probability that it will be realized
make up one behavioral approach that is used to assess the chance of success. Sensitivity analysis and
scenario analysis are also behavioral approaches for
dealing with project risk to capture the variability
of cash inflows and NPVs. Simulation is a statistically based approach that results in a probability
distribution of project returns. It usually requires a
computer and allows the decision maker to understand the risk-return tradeoffs involved in a proposed investment.
LG2 Discuss the unique risks that multinational
companies face. Although the basic capital
budgeting techniques are the same for multinational
and purely domestic companies, firms that operate
in several countries must also deal with both exchange rate and political risks, tax law differences,
transfer pricing, and strategic rather than strictly
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- Fall '13