Question

Garcia Real Estate is involved in commercial real estate ventures throughout the United States. Some of these ventures are much riskier than other ventures because of market conditions in different regions of the country. If Garcia does not risk-adjust its discount rate for specific ventures properly, which of the following is likely to occur over time?

a. The firm will reject too many relatively safe projects.
b. The firm will make poor capital budgeting decisions that could jeopardize the long-run viability of the company.
c. The firm will become less risky.

Answer 1

Answer: a. The firm will reject too many relatively safe projects.

b. The firm will make poor capital budgeting decisions that could jeopardize the long-run viability of the company.

Step-by-step explanation:

Both Options A and B are correct.

The firm will reject too many relatively safe projects.

=> If Garcia do not risk adjust discount rates for specific ventures they might end up foregoing projects that they believe will not be very viable even though if adjusted for risk they would be quite viable and quite safe.

The firm will make poor capital budgeting decisions that could jeopardize the long-run viability of the company.

=>Garcia stands to make quite a bit of losses from poor capital budgeting decisions because they are not adequately compensating for risk. If they do not specifically adjust certain ventures for the risk inherent in them, they would be requiring rates that are too low for the Investment which can result in them losing their investment because they went into a venture that was too risky and did not account for it.