Final Answer:
In capital budgeting, risk refers to the degree of variability of the cash inflows.
Step-by-step explanation:
Risk in capital budgeting pertains to the variability or uncertainty associated with the cash inflows generated by an investment. This concept is crucial for making informed financial decisions as it helps assess the potential fluctuations in the expected returns.
To elaborate, when evaluating investment projects, analysts often use metrics like the standard deviation or coefficient of variation to measure the degree of variability in cash inflows. A higher degree of variability indicates a riskier investment, as there is greater uncertainty regarding future returns.
Calculating risk involves analyzing the historical or projected cash inflows and determining how much they deviate from the expected values. For instance, if Project A has a higher standard deviation in cash inflows compared to Project B, it suggests that Project A is riskier.
This information is essential for investors and companies to make well-informed decisions, especially when comparing multiple investment opportunities. By understanding the degree of variability in cash flows, decision-makers can factor in risk when assessing the overall feasibility and attractiveness of a particular investment project.
In summary, the final answer identifies risk in capital budgeting as the degree of variability of cash inflows. The explanation underscores the significance of this concept in evaluating investment projects, emphasizing the use of metrics like standard deviation to quantify and compare the level of risk associated with different investment opportunities.