Economics Capital Budgeting Questions
The different types of risk faced in capital budgeting decisions are as follows:
1. Business risk: This refers to the risk associated with the company's ability to generate sufficient cash flows to cover the costs and risks of the investment project. It includes factors such as market demand, competition, and technological changes.
2. Financial risk: This relates to the risk associated with the company's capital structure and financing decisions. It includes factors such as interest rate fluctuations, debt levels, and the company's ability to meet its financial obligations.
3. Project-specific risk: This refers to the risk associated with the specific investment project itself. It includes factors such as the project's technical feasibility, potential cost overruns, and the uncertainty of achieving projected cash flows.
4. Country or political risk: This relates to the risk associated with the political and economic stability of the country in which the investment project is located. Factors such as changes in government policies, regulations, and currency exchange rates can impact the project's profitability.
5. Market risk: This refers to the risk associated with changes in market conditions that can affect the project's revenues and costs. Factors such as changes in consumer preferences, inflation, and fluctuations in input prices can impact the project's profitability.
6. Liquidity risk: This relates to the risk associated with the company's ability to convert the investment project into cash quickly and at a fair price. It includes factors such as the availability of buyers or investors, market conditions, and the ease of selling the project if needed.
It is important for companies to assess and manage these various types of risks when making capital budgeting decisions to ensure the success and profitability of their investment projects.