How to Evaluate the Purchase of an Asset whose Risk is Greater than the Current Risk of the Firm
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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. Increase the IRR of the asset to reflect the greater risk.
b. Increase the NPV of the asset to reflect the greater risk.
c. Reject the asset, since its acceptance would increase the firm's risk.
d. Ignore the risk differential, if the asset to be accepted would comprise only a small fraction of the firm's total assets.
e. Increase the cost of capital used to evaluate the project to reflect the project's higher risk.
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Solution Summary
The solution explains the method to evaluate such an asset, backed up by a short calculation.
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e) When the purchased asset is riskier than the current risk, the cost of capital should be ...
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