The relative risk of a proposed project is best accounted for by which of the following procedures?
A) Adjusting the discount rate upward if the project is judged to have above-average risk.
B) Adjusting the discount rate upward if the project is judged to have below-average risk.
C) Reducing the NPV by 10% for risky projects.
D) Picking a risk factor equal to the average discount rate.
E) Ignoring risk because project risk cannot be measured accurately.

Question

Quizplus · Accepted Answer

The best way to account for the relative risk of a proposed project is by adjusting the discount rate upward if the project is judged to have above-average risk. This is because a higher discount rate reflects the higher risk and lower present value of future cash flows. Adjusting the discount rate downward for below-average risk would not account for the relative risk of the project. Options C and D do not provide a consistent approach to adjusting for risk, and option E is not a valid approach as project risk can be quantified and measured.

The Relative Risk of a Proposed Project Is Best Accounted