Question

8. Risk analysis in capital budgeting Projects differ in risk, and risk analysis is a critical component of the capital budgeting process. Consider the case of United Recycling Inc.: United Recycling Inc. is one of the largest recyclers of glass and paper products in the United States. The company is looking into expanding into the cardboard recycling business. The company's CFO has performed a detailed analysis of the proposed expansion. The selling price of recycled cardboard can fluctuate dramatically, depending on the market conditions. By creating models that used different assumptions for the selling price of recycled cardboard but keeping all other inputs in the model the same, the CFO demonstrated the effect of fluctuations in the price of recycled cardboard

Answer 1

Sensitivity analysis meausies how much does the dependent variable changes by changing the value of the independent variable k. It changes the value of one input while keeping all the other inputs constant .

So. The CFO is conducting a sensitivity analysis on the financial model.

So the correct option is option 1.

Scenario analysis lists a number of the inputs that can affect the model and it changes the values of each input under different scenarios.

Market risk or beta is determined by the market movements and it is the risk in a project that for a well diversified investor .

Stand alone risk is the risk that is measured by the variability of a projects expected return irrespective of any other project of the company.

Corporate risk is risk of a project while considering all the other projects of the firm as well.

So the correct option is option 2.

When dealing with stand alone risk ,diversification is totally ignored. This risk ignores the diversification between different projects of a firm as well as the investors diversification within different firms and sectors of the industry .

Market risk is the risk that a well diversified investor faces in a project.

Corporate risk considers diversification among the projects of the firm.

So, the correct option is option c.