Taussig Technologies is considering two potential projects, X and Y. In assessing the projects' risks, the company estimated the beta of each project versus both the company's other assets and the stock market, and it also conducted thorough scenario and simulation analyses. This research produced the following data: Correlation of the project cash flows with cash flows from currently existing projects. Cash flows are not correlated with the cash flows from existing projects. Cash flows are highly correlated with the cash flows from existing projects. Which of the following statements is CORRECT?
A) Project X has more stand-alone risk than Project Y.
B) Project X has more corporate (or within-firm) risk than Project Y.
C) Project X has more market risk than Project Y.
D) Project X has the same level of corporate risk as Project Y.

Question

Taussig Technologies is considering two potential projects, X and Y. In assessing the projects' risks, the company estimated the beta of each project versus both the company's other assets and the stock market, and it also conducted thorough scenario and simulation analyses. This research produced the following data:  Correlation of the project cash flows with cash flows from currently existing projects. Cash flows are not correlated with the cash flows from existing projects. Cash flows are highly correlated with the cash flows from existing projects. Which of the following statements is CORRECT?
A) Project X has more stand-alone risk than Project Y. 
B) Project X has more corporate (or within-firm) risk than Project Y. 
C) Project X has more market risk than Project Y. 
D) Project X has the same level of corporate risk as Project Y.

Quizplus · Accepted Answer

The correlation of the project cash flows with the cash flows from currently existing projects indicates the corporate risk of the project. Since Project X has uncorrelated cash flows with existing projects, it has less corporate risk than Project Y, which has highly correlated cash flows with existing projects.

The beta of each project versus the stock market indicates the market risk of the project. The scenario and simulation analyses would have also helped in assessing the stand-alone risk of each project. The question does not provide any information to compare the stand-alone risk of the projects. Therefore, we cannot conclude anything about the stand-alone risk of the projects.

Taussig Technologies Is Considering Two Potential Projects, X and Y