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 downward if the project is judged to have above-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

Adjusting the discount rate upward if the project is judged to have above-average risk is the best procedure for accounting for the relative risk of a proposed project. This is because the discount rate reflects the time value of money as well as the riskiness of the project. The higher the risk of the project, the higher the discount rate should be to reflect the increased risk. Adjusting the discount rate downward for a riskier project would result in a higher present value of the project's cash flows, which may overestimate the project's value. Similarly, reducing the NPV by a fixed percentage for risky projects does not take into account the specific risk of the project, while picking a risk factor equal to the average discount rate may not accurately reflect the project's risk. Ignoring risk altogether is also not a viable option as it may lead to incorrect investment decisions.

Relative Risk of a Proposed Project Is Best Accounted for by Which