Chapter 13 Discussion Questions If corporate managers are risk-averse, does this mean they will not take risks? Risk-averse corporate managers are not unwilling to take risks, but will require a higher return from risky investments. There must be a premium or additional for risk taki Discuss the concept of risk and how it might be measured Risk may be defined in terms of the variability of outcomes from a given investment. The greater the variability, the greater the risk. Risk may be measured in terms of the coefficient of variation in which we d ivide the or measure of dIsp n)by the mean. We also may measure risk in terms of beta, in which we determine the volatility of returns on an ind ividual stock relative to a stock market index 13-3. When is the coefficient of variation a better measure of risk than the standard deviation? The standard deviation is an absolute measure of dispersion while the coefficient of variation is a relative measure and allows us to relate the standard deviation to the mean The coefficient of Icient of variation is a better measure o dispersion when we wish to consider the relative size of the standard deviation or compare two or more investments of different size 13-4 Explain how the concept of risk can be incorporated into the capital bud geting Risk may be introduced into the capital bud geting process by requiring higher returns for risky investments. One method of achieving this is to use higher discount rates for riskier investments. This risk-adjusted discount rate approach specifies different discount rates for different risk categories as measured by the coefficient of variation or some other factor. other methods such as the certainty equivalent approach, also may be use S-477 Copyright C2005 by The McGramw-Hill Companies, Inc.Copyright © 2005 by The McGraw-Hill Companies, Inc. S-477 Chapter 13 Discussion Questions 13-1. If corporate managers are risk-averse, does this mean they will not take risks? Explain. Risk-averse corporate managers are not unwilling to take risks, but will require a higher return from risky investments. There must be a premium or additional compensation for risk taking. 13-2. Discuss the concept of risk and how it might be measured. Risk may be defined in terms of the variability of outcomes from a given investment. The greater the variability, the greater the risk. Risk may be measured in terms of the coefficient of variation, in which we divide the standard deviation (or measure of dispersion) by the mean. We also may measure risk in terms of beta, in which we determine the volatility of returns on an individual stock relative to a stock market index. 13-3. When is the coefficient of variation a better measure of risk than the standard deviation? The standard deviation is an absolute measure of dispersion while the coefficient of variation is a relative measure and allows us to relate the standard deviation to the mean. The coefficient of variation is a better measure of dispersion when we wish to consider the relative size of the standard deviation or compare two or more investments of different size. 13-4. Explain how the concept of risk can be incorporated into the capital budgeting process. Risk may be introduced into the capital budgeting process by requiring higher returns for risky investments. One method of achieving this is to use higher discount rates for riskier investments. This risk-adjusted discount rate approach specifies different discount rates for different risk categories as measured by the coefficient of variation or some other factor. Other methods, such as the certainty equivalent approach, also may be used