Principles of Managerial Finance



Resource: Principles of Managerial Finance, Ch. 12

Complete the following problems in Ch. 12:

  • P-12-1
  • P12-3
  • P12-6
  • P12-17
  • P12-19



Risk and Refinements in Capital Budgeting

Learning Goals

  • LG 1 Understand the importance of recognizing risk in the analysis of capital budgeting projects.
  • LG 2 Discuss risk and cash inflows, scenario analysis, and simulation as behavioral approaches for dealing with risk.
  • LG 3 Review the unique risks that multinational companies face.
  • LG 4 Describe the determination and use of risk-adjusted discount rates (RADRs), portfolio effects, and the practical aspects of RADRs.
  • LG 5 Select the best of a group of unequal-lived, mutually exclusive projects using annualized net present values (ANPVs).
  • LG 6 Explain the role of real options and the objective and procedures for selecting projects under capital rationing.

Why This Chapter Matters to You

In your professional life

ACCOUNTING You need to understand the risk caused by the variability of cash flows, how to compare projects with unequal lives, and how to measure project returns when capital is being rationed.

INFORMATION SYSTEMS You need to understand how risk is incorporated into capital budgeting techniques and how those techniques may be refined in the face of special circumstances so as to design decision modules for use in analyzing proposed capital projects.

MANAGEMENT You need to understand behavioral approaches for dealing with risk, including international risk, in capital budgeting decisions; how to risk-adjust discount rates; how to refine capital budgeting techniques when projects have unequal lives or when capital must be rationed; and how to recognize real options embedded in capital projects.

MARKETING You need to understand how the risk of proposed projects is measured in capital budgeting, how projects with unequal lives will be evaluated, how to recognize and treat real options embedded in proposed projects, and how projects will be evaluated when capital must be rationed.

OPERATIONS You need to understand how proposals for the acquisition of new equipment and plants will be evaluated by the firm’s decision makers, especially projects that are risky, have unequal lives, or may need to be abandoned or slowed, or when capital is limited.

In your personal life

Risk is present in all long-term decisions. When making personal financial decisions, you should consider risk in the decision-making process. Simply put, you should demand higher returns for greater risk. Failing to incorporate risk into your financial decision-making process will likely result in poor decisions and reduced wealth.

YPF Argentina Seizes Oil Company from Spanish Owners


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