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 required rate of return used to evaluate the project to reflect the higher risk of the project.

Question

Quizplus · Accepted Answer

The best choice is to increase the required rate of return used to evaluate the project to reflect the higher risk of the project. This is because the required rate of return is a reflection of the risk associated with an investment, and increasing it would ensure that the investment returns enough to justify the risk. This approach is commonly referred to as adjusting the discount rate. Options A and B are incorrect because IRR and NPV are not adjusted for risk, but rather they are metrics that are influenced by the discount rate. Option C is unnecessarily strict, since it assumes that any increase in risk is unacceptable. Option D is incorrect because the size of the investment is not necessarily correlated with the level of risk.

A Firm Is Considering the Purchase of an Asset Whose