Case Background
As firms age, managers may expand activities a firm engages in. As a firm’s scope of activities is widened, diversification may affect a firm’s overall level of risk. Risk is measured by the standard deviation of project returns. Chapter 9 (section 9.3) introduces the principle of diversification as a means of reducing or eliminating firm-specific risk. CAPM (see p. 346 of our required textbook) utilizes the principle of diversification to identify an efficient portfolio of assets maximizing investment returns for a given level of market risk. Beta, or a measure of the sensitivity of a stock or portfolio to market risk, is an element of CAPM especially helpful to a firm’s financial managers and investors. This discussion revolves around a firm’s use of these tools in determining how a new investment project may potentially affect the firm. The new project appears to have a different risk profile than other elements of the firm. In this case, financial managers must make decisions as to how the new project will be assessed from a financial standpoint.
Case
Text Transcript
Case Questions
Initial Post
Remember that your Board consists of arts patrons without financial expertise or training. Based upon this module’s required reading and the background information given, form an initial post covering the following three issues:
Section 1
Explain one reason why this project (NOH Live) is expected to lower risk through its effect on the standard deviation of project returns. Consult p. 339 of our required text for information.
Section 2
Explain the principle of diversification and draw one parallel between NOH Live and a listed small-cap firm of your choosing in a different sector (see Resource to use below) illustrating how the principle of diversification may lower risk in relation to returns. Refer to pp. 311-317 and 340-346 for more information.
For the principle of diversification to apply, you will want to choose a comparison firm that is dissimilar from NOH Live, such as a radio/media firm called E.W. ScrippsLinks to an external site., which is presented as having stable revenues and a lower Beta than the opera/ballet performance house.
Section 3
Comment on limitations of using historical returns to measure firm-specific risk. You may consult pp. 308-317 and 351-353 of our required text for information.
