Question

If the risk of an investment project differs from the overall firm’s risk then: the project’s discount rate must be adjusted based on the risks of the project’s cash flows. the project’s initial cost should be increased/decreased to account for the increase/decrease in risk. the average rate used for all prior projects should be used as the new project’s discount rate. the market rate of return should be used as the project’s discount rate. the project’s discount rate must be adjusted based on the sources of project financing.

Answer 1

Answer: the project’s discount rate must be adjusted based on the risks of the project’s cash flows.

Step-by-step explanation:

If the risk of the Investment project varies from the risk of the firm, it cannot be analysed the same way the firm can. When such a situation arises, it is important that a correct measure of risk is used. The best one would be to use the risks based on the Project's cashflows as this will give a true description of if the project is a good fit for the company. This risk should then be used to adjust Discount Rate so that it is accounted for in it.