Chapter 1l Capital Budgeting and Risk Analysis o 2002. Prentice Hall. nc
Chapter 11: Capital Budgeting and Risk Analysis © 2002, Prentice Hall, Inc
Three Measures of a Projects Risk Project standing Alone risk
Three Measures of a Project’s Risk Project Standing Alone Risk
Three Measures of a Projects Risk Project standing Alone risk Risk diversified away within firm as this project is combined with firn’ s other projects and assets
Three Measures of a Project’s Risk Project Standing Alone Risk Risk diversified away within firm as this project is combined with firm’s other projects and assets
Three Measures of a Projects Risk Project standing Alone risk Risk diversified away within firm as this P rolec project is combined contribution with firn’ s other to-firm risk projects and assets
Three Measures of a Project’s Risk Project Standing Alone Risk Risk diversified away within firm as this project is combined with firm’s other projects and assets Project’s contributionto-firm risk
Three Measures of a Projects Risk Project standing Alone risk Risk diversified away within firm as this Proiect project is combined contribution with firn’ s other to-firm risk projects and assets Risk diversified away by shareholders as securities are combined to form diversified portfolio
Three Measures of a Project’s Risk Project Standing Alone Risk Risk diversified away within firm as this project is combined with firm’s other projects and assets Risk diversified away by shareholders as securities are combined to form diversified portfolio Project’s contributionto-firm risk
Three Measures of a Projects Risk Project standing Alone risk Risk diversified away within firm as this Proiect project is combined contribution with firn’ s other to-firm risk projects and assets Risk diversified away by shareholders as securities are combined tematic risk to form diversified portfolio
Three Measures of a Project’s Risk Project Standing Alone Risk Risk diversified away within firm as this project is combined with firm’s other projects and assets Risk diversified away by shareholders as securities are combined to form diversified portfolio Project’s contributionto-firm risk Systematic risk
Incorporating Risk into Capital Budgeting Two Methods Certainty Equivalent Approach Risk-Adjusted Discount Rate
Incorporating Risk into Capital Budgeting Two Methods: • Certainty Equivalent Approach • Risk-Adjusted Discount Rate
How can we adjust this model to take risk into account? ACFt NPⅤ ∑ IO (1+k)t t=1
How can we adjust this model to take risk into account? NPV = - IO ACFt (1 + k) t n t=1 S
How can we adjust this model to take risk into account? ACFt NPⅤ ∑ IO (1+k)t t=1 Adjust the After-tax Cash Flows(ACFs), or Adjust the discount rate(k)
How can we adjust this model to take risk into account? • Adjust the After-tax Cash Flows (ACFs), or • Adjust the discount rate (k). NPV = - IO ACFt (1 + k) t n t=1 S
Certainty Equivalent Approach Adjusts the risky after-tax cash flows to certain cash flows TThe idea
Certainty Equivalent Approach • Adjusts the risky after-tax cash flows to certain cash flows. • The idea:
