ch8 Risk Analysis in Investment Decisions.pptVIP

FIGURE 8-1 The Risk-Return Trade-Off FIGURE 8-2 Illustration of Investment Risk: Investment A Has a Lower Expected Return and a Lower Risk Than B An Example of Sensitivity Analysis TABLE 8-1 Book and Market Values of Timberland Company’s Debt and Equity (December 31, 1998) TABLE 8-2 Calculation of Timberland’s Cost of Capital FIGURE 8-3 An Investment’s Risk-Adjusted Discount Rate Increases with Risk Cash Flow Diagrams for ABC Enterprises’ Investment Cash Flow Diagrams for ABC Enterprises’ Investment TABLE 8-3 When Evaluating Investments under Inflation, Always Compare Nominal Cash Flows to a Nominal Discount Rate or Real Cash Flows to a Real Discount Rate ($ millions) TABLE 8-4 General Design’s Diamond Film Project ($ millions) TABLE 8-4 (Concluded) General Design’s Diamond Film Project ($ millions) TABLE 8-5 Use of a Constant Risk-Adjusted Discount Rate Implies That Risk Increases with the Remoteness of a Cash Flow (risk-free rate = 5%; risk-adjusted discount rate =10%) TABLE 8-6 Discounting an Investment’s Annual EVA Stream Is Equivalent to Calculating the Investment’s NPV TABLE 8-6 (Concluded) Discounting an Investment’s Annual EVA Stream IsEquivalent to Calculating the Investment’s NPV TABLE 8A-1 Representative Industry and Company Betas TABLE 8A-1 (Concluded) Representative Industry and Company Betas TABLE 8A-2 Diversification Reduces Risk *Copyright ? 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Irwin/McGraw-Hill* Chapter 8 Risk Analysis in Investment Decisions Expected return Interest rate on government bonds Investment risk Market line B A ? ? Probability (%) Investment A Investment B -50 -40 -30 -20 -10 0 10 20 30 40 50 60 70 80 90 Return (%) Risk-adjusted discount rate or expected return Investment risk Market line Increasing risk- adjusted discount rate Firm’s cost of capital Risk of firm’s existing assets Increasing investment risk $100 million $14 million per year The E