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Unformatted text preview: f a project's stand-alone risk to help form that judgment. Capital budgeting & risk, a reading prepared by Pamela Peterson Drake 12 5. Assessment of project risk in practice Most U.S. companies consider risk in some manner in evaluating investment projects. But considering risk is usually a subjective analysis as opposed to the more objective results obtainable with simulation or sensitivity analysis. Companies that use discounted cash flow techniques, such as internal rate of return and net present value methods, tend to use a single cost of capital. But using a single cost of capital for all projects can be hazardous. Suppose you use the same cost of capital for all your projects. If all of them have the same risk and the cost of capital you are using is appropriate for this level of risk, no problem. But what if you use the same cost of capital but your projects each have different levels of risk? Suppose you use a cost of capital that is the cost of capital for the company's average risk project. What happens when you apply discounted cash flow techniques, such as the net present value or t...
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This note was uploaded on 02/07/2014 for the course MIS 304 taught by Professor Mejias during the Spring '07 term at University of Arizona- Tucson.

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