Describe a process that firms often use to determine a project’s risk-adjusted costs of capital.

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Describe a process that firms often use to determine a project’s risk-adjusted costs of capital.

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Describe a process that firms often use to determine a project’s risk-adjusted costs of capital.

Explanation & AnswerSolution by a verified expert

Explanation

In order to determine the risk-adjusted cost of capital of a firm, first it needs to undergo a preliminary analysis wherein the value of the project is determined on the basis of the risk-adjusted cost of capital computed on the basis of the cost of capital in the similar projects undertaken by the company in the past.
 
Second, the company is required to conduct a quantitative analysis of the stand-alone risk of the project and finally, the corporate and market risk is incorporated in the cost of capital to eventually arrive at the true risk-adjusted cost of capital of the project.

Verified Answer

First, a risk-adjusted cost of capital is determined using the similar project that the firm has invested in the past. Now, a quantitative analysis is done and the corporate and the market risk is inculcated in the cost of capital to arrive at the correct risk-adjusted cost of capital of a project.

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