A firm is considering the purchase of an asset whose risk is greater than the current risk of the firm, based on any method for assessing risk. In evaluating this asset, the decision maker should
A) Increase the IRR of the asset to reflect the greater risk.
B) Increase the NPV of the asset to reflect the greater risk.
C) Reject the asset, since its acceptance would increase the risk of the firm.
D) Ignore the risk differential if the asset to be accepted would comprise only a small fraction of the total assets of the firm.
E) Increase the cost of capital used to evaluate the project to reflect the higher risk of the proj¬ect.

Question

Quizplus · Accepted Answer

When considering an asset with greater risk than the current risk of the firm, the decision maker should increase the cost of capital used to evaluate the project to reflect the higher risk of the project. This is because a higher cost of capital would decrease the NPV of the project, which would provide a more conservative analysis of the potential return on investment. This would ensure that the firm is adequately compensated for taking on the higher risk, and would also allow for a more accurate comparison of the potential returns of the project with other projects under consideration. The other options are not as effective in addressing the higher risk associated with the asset.

A Firm Is Considering the Purchase of an Asset Whose