What is the best approach to take into account the relative risk of a proposed project?
A)adjusting the discount rate upward if the project is judged to have above-average risk
B)reducing the NPV by 10% for risky projects
C)picking a risk factor equal to the average discount rate
D)ignoring risk because project risk cannot be measured accurately

Question

Quizplus · Accepted Answer

The best approach is to adjust the discount rate upward if the project is judged to have above-average risk. This is because the discount rate reflects the time value of money and the risk associated with the project. When a project is riskier than average, its cash flows are considered less certain, hence, to account for this uncertainty, the discount rate should be adjusted upwards. This will reduce the NPV of the project, reflecting the higher risk. Choice B is not recommended as it does not take into account the specific level of risk associated with the project. Choice C is not appropriate because the average discount rate may not be reflective of the level of risk associated with the proposed project. Choice D is not recommended because risk is an important consideration in investment decision making, and cannot be ignored.

What Is the Best Approach to Take into Account the Relative