MGT201 Financial Management GDB Solution Spring 2013

Stand-alone risk on an individual project may be very high but its actual risk may or may not be higher in the context of project’s effect on company’s common stockholders. Discuss both dimensions with conceptual rationale. 

Special Instruction: You are supposed to discuss both dimensions with conceptual rationale; the actual risk will be higher for which class of common stockholders and it will be lower for which class of common stockholders?

Solution:

It is important to note that investors make their decision based on expected returns and risk.
ƒ Actual returns may differ from expectedreturns, so actual returns are not always higher for higher risk investments in the short-run.
ƒ In the long-run, higher returns do generally occur for higher risk assets.

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