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A firm uses a single discount rate to compute the NPV of all its potential capital budgeting projects

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A firm uses a single discount rate to compute the NPV of all its potential capital budgeting projects, even though the projects have a wide range of nondiversifiable risk. The firm then undertakes all these projects that appear to have positive NPVs. Briefly explain why such a firm would tend to become riskier over time.

Use examples to help illustrate the explanation.

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Solution Summary

The correlation between undertaking projects with positive NPVs and risk is explained.

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A firm which uses a single discount rate to compute the NPV of all its potential capital budgeting projects, even though the projects have a wide range of non-diversifying risk tend to become riskier over time as it is neglecting the project specific risk. For understanding this in detail, let us know the basic capital budgeting steps (financingcp, 2009):

1) Identify potential projects
2) ...

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