A firm is considering a new project whose risk is greater than the risk of the firm's average project,based on all methods for assessing risk.In evaluating this project,what would it be reasonable for management to do?
A)increase the estimated IRR of the project to reflect its greater risk
B)reject the project, since its acceptance would increase the firm's risk
C)ignore the risk differential if the project would amount to only a small fraction of the firm's total assets
D)increase the cost of capital used to evaluate the project to reflect the project's higher-than-average risk

Question

Quizplus · Accepted Answer

The best choice would be to increase the cost of capital used to evaluate the project to reflect its higher-than-average risk. This is because the cost of capital reflects the risk level of a project or investment, and using a higher cost of capital would result in a lower net present value (NPV) for the project, making it less attractive for the firm. This adjustment would help ensure that the firm is adequately compensated for the increased risk associated with the project. Choices A, B, and C do not address the issue of risk-adjusted evaluation and could result in incorrect or suboptimal decisions.

A Firm Is Considering a New Project Whose Risk Is