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) decrease the internal rate of return (IRR) of the asset to reflect the greater risk.
B) decrease the net present value 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 from 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 from the project to reflect the higher risk of the asset. This is because the discount rate used to calculate the NPV of the asset should reflect the risk associated with the asset. By increasing the required rate of return, the NPV of the asset will be adjusted accordingly to reflect the higher risk. It is not appropriate to decrease the IRR or NPV of the asset or reject the asset outright, as these actions do not reflect the true risk associated with the asset. It is also not appropriate to ignore the risk differential, as this can lead to inaccurate valuation and decision-making.

A Firm Is Considering the Purchase of an Asset Whose