Adverse selection: Difference between revisions
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imported>Doug Williamson (Create the page. Source: ACT Corporate Finance and Funding exam solution October 2013, page 11.) |
imported>Doug Williamson m (Clarify wording by adding "new".) |
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One cause of adverse selection is using the wrong cost of capital for making the evaluation. | One cause of adverse selection is using the wrong cost of capital for making the evaluation. | ||
For example using a cost of capital which is either too low or too high, because of failing to take appropriate account of the relevant risk of the project under review. This can happen when a firm's existing average cost of capital is used to evaluate projects whose risk differs from the average risk of the firm's existing business. | For example using a cost of capital which is either too low or too high, because of failing to take appropriate account of the relevant risk of the project under review. This can happen when a firm's existing average cost of capital is used to evaluate new projects whose risk differs from the average risk of the firm's existing business. | ||
Revision as of 12:12, 13 March 2014
Project appraisal.
The problems of accepting projects which should be rejected, or rejecting ones which should be accepted.
One cause of adverse selection is using the wrong cost of capital for making the evaluation.
For example using a cost of capital which is either too low or too high, because of failing to take appropriate account of the relevant risk of the project under review. This can happen when a firm's existing average cost of capital is used to evaluate new projects whose risk differs from the average risk of the firm's existing business.
