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Unformatted text preview: oject increases owners'
wealth. From the perspective of the company, this required rate of return is what it costs to raise capital,
so we also refer to this rate as the cost of capital.
We refer to the compensation for risk as a risk premium -- the additional return necessary to compensate
investors for the risk they bear. How much compensation for risk is enough? 2 percent? 4 percent? 10
How do we assess the risk of a project? We begin by recognizing that the assets of a company are the
result of its prior investment decisions. What this means is that the company is really a collection or
portfolio of projects. So when the company adds another project to its portfolio, should we be concerned
only about the risk of that additional project? Or should we be concerned about the risk of the entire Capital budgeting & risk, a reading prepared by Pamela Peterson Drake 2 portfolio when the new project is included in it? To see which, let's look at the different dimensions of risk
of a project. B. Different types of project risk If we have some idea of the uncertainty associated with a project's future cash flows -- its possible
outcomes -- and the probabilities associated with these outcomes, we will have a measur...
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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.
- Spring '07