Risk in a revenue-producing project can best be adjusted for by:
A) ignoring it.
B) adjusting the discount rate upward for increasing risk.
C) adjusting the discount rate downward for increasing risk.
D) Picking a risk factor equal to the average discount rate.
E) reducing the NPV by 10 percent for risky projects.

Question

Quizplus · Accepted Answer

Adjusting the discount rate upward for increasing risk is the best way to adjust for risk in a revenue-producing project. This is because a higher discount rate reflects the increased risk associated with the project, which in turn decreases the present value of the project's expected cash flows. This adjustment provides a more accurate picture of the project's potential profitability given the level of risk involved. Ignoring risk, adjusting the discount rate downward for increasing risk, or picking a risk factor equal to the average discount rate are all suboptimal approaches to handling risk. Reducing the NPV by 10 percent for risky projects is a rough estimate rather than a precise method of adjusting for risk.

Risk in a Revenue-Producing Project Can Best Be Adjusted for By