If a project’s stand-alone, corporate, and market risk are known to be highly correlated, how would this affect risk analysis? Explain.
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If a project’s stand-alone, corporate, and market risk are known to be highly correlated, how would this affect risk analysis? Explain. |
Explanation
The risk of a project is dependent upon its stand-alone risk, which is the risk of uncertainty in the project's cash flows. But, if the stand-alone risk is correlated with the corporate and the market risk, then it can be said that the required return on equity is equal to the project's required return. Therefore, any change in the market conditions will directly affect the project's net present value (NPV).
Verified Answer
The project will directly get affected by the uncertainties if the stand-alone risk, market risk and the corporate risk are highly correlated. This is because the stand-alone risk affects the cash flows from a project; therefore, any uncertainty in the market, the cash flows will directly get affected.
