Risks and returns are significant aspects of consideration in the process of investment. The organization always compare risks and expected return from a specific investment. Higher risks complimentarily denote that higher compensation can be accrued, but the volatility of the investment will also be high. Risks are the level of uncertainties, while returns are the profits generated from a given investment. After investing in a project, the organization expected to get some outcomes (Lee, So, & Wang, 2017). The result generated from the investments is the return from the project. Companies will always expect to maximize wealth obtained through the time value of money.
Before making an investment decision, investors will always look into the balance between the risk and the expected return of the prospective project. Decisions are made based on returns that are deemed acceptable. Principally, since investors are risk-averse, they will always invest in projects with higher expected returns at a lower expected risk. ( Lee, So, & Wang, 2017). The firm-level of risk tolerance plays a significant role in investment decision making; this justifies the continued investment analysis tailored to obtain the maximum returns at lower risk possible.
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The company should invest in building the new factory because the marker return is higher than the risk-free rate of return. The new factory has a positive risk premium, which is the compensation from the amount of risk taken to invest in the project (Fifield, McMillan & McMillan, 2020) . Also, the project has expected return higher than the minimum required return, which equals the cost of capital. Furthermore, the expected return is higher than the benchmark return, which is roughly 7%. Therefore, the company is likely to make profits; thus, wealth maximization for the organization. Therefore, any organization needs to understand risks and returns for the project before making any investment decision. This will be integral in reducing the number of shocks that may influence the firm's operations, enhancing safety, and reduction of costs associated with risks.
References
Fifield, S. G., McMillan, D. G., & McMillan, F. J. (2020). Is there a risk and return relation?. The European Journal of Finance , 1-27.
Lee, C., So, E. C., & Wang, C. C. (2017). Evaluating firm-level expected-return proxies. Harvard Business School Accounting & Management Unit Working Paper , (15-022), 15-57.
